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Ed Dolan's Econ Blog

Did Austerity Work in Britain? One Chart Tells It All

The general election campaign is in full swing in Britain, and it seems it’s all about austerity. From London, The New York Times reports that the campaign revolves around a single issue: the economy, and whether its rebound is the result of an austerity policy championed by the Conservative-led government of David Cameron, or in spite of it.

When in doubt, we should let the facts speak for themselves. This chart tells it all:

The points in the chart represent thirty of the high-income democracies that comprise the OECD. It covers the years 2010-2014, the Cameron government’s term in office. The vertical axis shows the average annual rate of growth during the period. The horizontal axis shows the degree of austerity, or fiscal consolidation, as economists prefer to call it, applied in each country. The UK is right in the middle, just slightly below average in terms both of austerity and growth.

Some technicalities: The horizontal axis shows the annual change in what the OECD calls the government’s underlying primary balance, also known as the structural or cyclically adjusted primary balance. This measure of the stance of fiscal policy differs from the more commonly reported current budget surplus or deficit in four ways:

  • First, it shows what the surplus or deficit would be if the economy were operating at its potential real output, or “full employment,” to use the popular term. The current surplus or deficit can change from year to year either because of changes in tax and spending policy, or because a change in GDP triggers so-called automatic stabilizers, for example, lower tax receipts and higher unemployment benefits when the economy enters a recession. The structural balance thus isolates the part of the current budget balance that we can attribute to policy rather than the state of the business cycle.
  • Second, it we call it the “primary” deficit because it omits interest payments on government debt. The intention, as with the adjustment for cyclical factors, is to make it a better measure of policy changes that policy makers can actually control. A government has considerable freedom to change taxes and current spending programs from one year to the next, but short of default or negotiated restructuring of its debt, there is little it can do to affect interest payments.
  • Third, the OECD data cover all levels of government. Doing so allows us to compare countries like the United States, where people often focus on the federal budget, even though it only accounts for 60 percent of all government spending, with countries like France or the UK, where taxes and spending are much more centralized.
  • Fourth, the underlying balance also eliminates the effect of one-off fiscal measures like privatization revenues or transfers from the central bank to the government budget. Eliminating one-offs helps comparison both among countries and over time, since they vary greatly from country to country and year to year.

In case you didn’t really want to know all of the above, just take it on faith that the horizontal axis measures the degree of austerity. Any point to the right of the vertical axis means the government is using tax increases or spending cuts to tighten fiscal policy from one year to the next. The farther to the right, the more austere.

The bottom line

So how does this chart help us understand the election debate?

Most importantly, at least for OECD countries in the period we are looking at, it is simply untrue that austerity is good for growth. On average, as the trendline shows, tightening the budget by one percent of GDP cuts about half a percentage point off the growth rate. That finding, by the way, omits the influence of Greece. Greece has undergone extreme austerity and its growth has been abysmal, so including it would make the growth-austerity relationship even more negative.

We also see that the relationship between austerity and growth is not very tight. Fiscal policy is simply not the whole story. The United States, for example, underwent more fiscal consolidation than the UK in 2010-2014, but it also had better growth. On the other hand, the countries of the Eurozone, on average, grew more slowly than the OECD average despite a similar average level of austerity.

In short, it is much easier to argue that the British economy has recovered despite austerity than because of it. Its strengths lie in other growth-friendly policies—good trade relations with the United States, which has itself enjoyed a stronger-than-average recovery;  a business-friendly legal and regulatory environment (ranking eighth on the World Bank’s Ease of Doing Business index, just behind the US); and the good sense to stay out of the euro.

On the other hand, the chart makes it hard to understand why politicians, the press, and the public see this election as being all about austerity. After all, the UK is right smack in the middle of the chart. It has had neither an exceptional amount of fiscal consolidation nor exceptional growth performance. So what is all the fuss about?

Related posts

How Gordon Brown Saved Britain from the Euro, and Why That Makes Him a Hero

As the US Moves into Budget Chaos, Just How Bad is Fiscal Policy, Really?

Why Angry Greek Voters Backed a Change in Fiscal Policy. What Lessons for America?

Appendix

I try not to clutter my posts with excessive detail, but sometimes that turns out to be a mistake. Several readers, both in the comment thread on this site and on other sites where the above has been cross-posted, have asked for more detail. For their benefit, here is a table that will allow identification of the individual country points (sorry, not room on the chart for so many labels). Also, I have attached a version of the chart that separates the sample into euro and noneuro countries. As we would expect, the negative relationship between fiscal consolidation and growth is much stronger for members of the euro zone, but it is negative for both sub-samples.  

 

14 Responses to “Did Austerity Work in Britain? One Chart Tells It All”

windrivenApril 8th, 2015 at 9:38 am

Does austerity work? It depends on how one defines 'work.'

First, if one removes Greece from the mix the slope of the line would doubtless change.

Second, the dusting of data points without country names attached obscures more than it reveals. There is may be lessons to draw from this chart, but there is much, much more to the economies represented than loose or tight money. Which data point is Germany? Which is Denmark? Which is Portugal?

Third, despite rather different approaches to monetary policy, the US fared only slightly better than the UK on the measure of GDP growth according to the chart.

The chart is fruit salad. Comparing this grape with that strawberry does not, in my estimation, tell all … or even actually very much.

lorenzofromozApril 8th, 2015 at 11:01 pm

Should we not, perhaps, separate out those countries with independent monetary policies, and those without?

Ed Dolan EdDolanApril 9th, 2015 at 7:46 am

You say, "The chart ….does not, in my estimation, tell all … or even actually very much. "

I can see that I have done a poor job of explaining myself. Let me try again to say what I think the chart shows and does not show.

1. As I understand it, the hypothesis of the Conservative government is that (as the NYT puts it) the UK economy has recovered because of, as opposed to in spite of, their austerity policies. Some people claim they don't say that outright, but somehow they have created an impression to that effect in the press and the public, and they aren't shouting from the rooftop to correct that impression.

2. If we translate into economic terms, the claim gives us a hypothesis to test, namely, that there is a positive relationship between fiscal consolidation and growth over the time span of their period in office. If confirmed, the hypothesis would imply a tight scatter of points around a positively sloped trend line.

3. The null hypothesis is a weak cluster, or a trendline that is not positively sloped, or both.

4. Although this is not a research paper, I believe that by fair standards of casual discourse, the cart supports the following conclusions:

a. "in the period we are looking at, it is simply untrue that austerity is good for growth," by which I mean that it is apparent to the naked eye that the chart does not allow us to reject the null hypothesis.

b. "We also see that the relationship between austerity and growth is not very tight. Fiscal policy is simply not the whole story." That is, I conclude that the broad scatter ("fruit salad," you aptly call it) suggests that other factors are at work that strongly influence performance. I suggest several without actually testing them.

c. I think that (a) and (b) together justify my summary conclusion that "it is much easier to argue that the British economy has recovered despite austerity than because of it."

I am surprised an pleased that my readers want more detail, not less. I am always afraid that these blogs are too wonky and chart-filled. I have now added an appendix with a table that allows identification of individual country points and a modified chart that separates euro and non-euro subsamples.

Ed Dolan EdDolanApril 9th, 2015 at 7:46 am

Done. See newly added appendix at the end of the post. Thank you for your comment. See also my reply to "Windriven" earlier in this comment thread.

windrivenApril 9th, 2015 at 3:12 pm

You and I seem to interpret 'fruit salad' differently. I meant to suggest that the economies of the countries in your chart were extremely different. I made my own chart using your data for large, mature, industrial economies: US, UK, GER, CAN, FRA, JAP, and plotted Euro Area (a disaster) and OECD as well. My result for the six economies that I chose as reasonably similar produced essentially a straight line passing pretty close to the OECD data point. Euro Zone was out in the swamps (which suggests something outside the discussion immediately at hand).

What my chart told me is that historically strong economies pretty much did OK while historically shaky economies didn't fare so well. It also tells me that the Euro Zone doesn't fare well in tough times, something I associate with the inability to manage their own monetary policy, and in fact something that supports your basic premise, viz. that generally weak economies require a lot of pumping in tough times.

I would argue that the pumping is a band-aid and that the real solution is to invigorate the economies by stimulating business and entrepreneurship. Greece with its moribund private sector is a fine example.

So cutting to the chase, I would agree with you on 4a that austerity is not closely linked with good growth but I would also note that the data (for mature industrial economies) doesn't suggest that hearty pumping is closely linked either. I would conclude that fiscal policy had similar effect to the broom brigade in a curling match; it had an influence but that influence was rather less acute than politicians and economists would have us believe regardless of which side of the divide they're on.

In any event, this was a most stimulating and interesting post, Dr. Dolan.

mechemanMay 19th, 2015 at 9:17 am

How can you make such a strong claim when the correlation coefficient on the data is awful? (-0.245 for non-EU, admittedly decent for EU, and not indicated for OECD overall). The fitting weight should be adjusted by GDP (i.e. US, Germany, France, etc. count heavier on the trendline, Portugal, Greece, etc. count less). Additionally, outliers (Greece) should not be used to draw a trendline, unless there is some robust justification, for example, if there were a country which massively increased spending and saw a huge increase in growth, and both outliers fit the overall trend. With these two factors I think you would have a much flatter trendline.

I think the strongest conclusion you can make from the data is that it is not clear if austerity has a large effect on growth (either positive or negative), and I would agree with windriven that historically weak economies did worse, whereas more robust economies fared moderately well.

Ed Dolan EdDolanMay 19th, 2015 at 8:11 pm

I don't think you read the post very carefully.

(1) I don't make a very strong claim. My bottom line is that the data does not support the hypothesis that austerity has helped the UK economy. The very weakness of the correlation undermines that claim. If we want to argue at all from the (weak) data, it is easier to argue that the economy has recovered despite, rather than because of, austerity. That sounds to me exactly like the "strongest conclusion" that you say I can draw.

(2) For exactly your reasons, I specifically excluded Greece when drawing the trendline, as noted in the post.

(3) In the addendum, I included Greece in the euro trendline because I think there is a "strong reason" for doing so, namely, that membership in the euro has arguably been a cause of its exceptionally weak performance.

mechemanMay 20th, 2015 at 5:55 am

1) My apologies, perhaps we do agree on more than I initially thought. Still, the simple act of including a trendline implies that there is some correlation, even when it is very weak or unclear, and this is something I see very often in economic data.

3) Indeed the trend for EU looks stronger. It would be interesting to compare other blocs with the same currency, such as the 50 US states, or the UK by regions, though such a comparison would be more difficult, and fundamentally different from the Eurozone case.

Ed Dolan EdDolanMay 20th, 2015 at 6:33 am

I guess what impressed me mostly was not the trendline, but the weakness of the cluster. It is sort of whether you look at the forest or the trees.

BTW, you probably saw it, but I should have mentioned for the benefit of other readers of our exchange that my reply to Windriven (second item in the above discussion thread) also bears on our discussion here.

JJLehtoMay 26th, 2015 at 10:54 pm

Of course the right has long abandoned "It's good for the economy" I'm not sure anyone can sincerely believe that anymore… They seem to have moved onto "It is necessary". "This is the pain we need to accept to bring gov debt down" but then Debt to GDP ratios kept rising.

I think the current argument has been…I'm not quite sure, but I don't think anyone can sincerely claim it's good for the economy!

Ed Dolan EdDolanMay 27th, 2015 at 6:18 am

If it's bad for the economy, that raises the question, what is it good for? Surely, debt reduction is not an end in itself.

JJLehtoMay 27th, 2015 at 1:28 pm

Well, that is indeed my question. I wonder what the justification is now, as debt to GDP ratios have risen, how do they continue to justify it?