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Why Some Say Larry Summers Is Wrong About UK ‘Lost Decade’

Matt Clinch, special to CNBC.com
Tuesday, 18 Sep 2012 | 9:12 AM ET

Former U.S. Treasury Secretary, Larry Summers has argued the U.K. faces a lost decade like Japan unless the government changes its economic policies, but economists and experts have told CNBC that the reasons Summers cites are wrong.

Lawrence Summers, Director of President Barack Obama's National Economic Council
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Lawrence Summers, Director of President Barack Obama's National Economic Council

Summers, writing in the Financial Times, urged the U.K. government to drop its current austerity push and opt for a more Keynesian approach, by stimulating its economy.

He said rather than starving public investment, reforms should be put in place to boost growth and confidence.

But Mark Littlewood, Director General of the Institute of Economic Affairs — a U.K. based think tank — says that he disagrees with Summers’ understanding of the facts.

“Although the U.K. government talks a tough game on austerity/fiscal consolidation, it is actually undertaking a fiscal stimulus program which is very similar in scale to that of the U.S.,” he told CNBC.com.

Littlewood says that Summers has embraced the coalition’s political rhetoric rather than attempting to audit its actions.

“The problem for Keynesians is that the U.K. has had an enormous fiscal stimulus since the 2008 crash.”

“It is Osborne’s professed intention to add 600 billion pounds ($975 billion) to the national debt over the course of this parliament, in very rough terms,” Littlewood said, adding that the U.K. budget deficit was around 8 percent of GDP every year — about the same as America.

“If the growth figures are disappointing — which they are — this is surely not a sign of failed fiscal consolidation, but good evidence that fiscal stimulus doesn’t work.”

Gross domestic product (GDP) in the U.K. fell by 0.5 percent in the second quarter as the country entered a double-dip recession. But the Conservative-led government has continued to champion spending cuts and has resisted changing course.

David Riley, Head of Global Sovereign Ratings at Fitch said last month that any deviation from the current plan could affect the U.K.’s triple-A rating.

Summers, who served as the chief economic adviser to President Barack Obama, was one of the key architects of the 2009 U.S. stimulus package — a $800 billion plan which included increased spending on infrastructure and aid to boost the economy after the financial crisis.

Ruth Lea, Economic Adviser at Arbuthnot Banking Group says while she agrees the U.K. needed some “Keynesian” stimulus, Summers had failed to provide any details on the size of the spending.

“I feel an injection of, say, 5 billion pounds ($8 billion) of capital spending should be considered by the government. I don’t believe this would be seen as a ‘reversal’ of the government’s deficit reduction policy, which has undoubtedly favorably impressed the markets,” she told CNBC.com.

“But 30-40 billion pounds, allied with talk of a ‘reversal’ of policy is a different matter. This would almost certainly be regarded unfavorably by the markets and the agencies.”

U.K. Government debt currently stands at approximately 85 percent of GDP compared to the U.S. where it is just over 100 percent.

James Knightley, U.K. Economist at ING, also believes that the statistics suggest that the austerity drive has yet to really take shape.

“If you look at what has been the strongest contributor to GDP growth in the past couple of years, it is actually government spending, while if you look at net-departmental government spending then that is little changed,” he told CNBC.com.

“So there isn't all that much evidence of austerity in the official numbers as yet.”

Knightley puts lack of growth down to real household disposable incomes which he says accounts for two-thirds of GDP.

“We should see real incomes rise next year given falling inflation and a surprisingly resilient labor market. This will be far more effective at generating growth than any temporary spending increase in my view,” he said.