The Perennial Debate: Spending or Austerity?

The UK finance minister (known as the Chancellor of the Exchequer), George Osborne, presents his annual budget to parliament next week. So it seems a good time to consider economic ideologies, but this being an international column, we won’t be parochial and recommend a wish-list for Osborne. Rather we’ll discuss just some of the measures that all governments currently stuck in a sclerotic cycle of high unemployment and stagnant growth should be implementing.

Chancellor of the Exchequer George Osborne holds Disraeli's original budget box as he leaves 11 Downing Street for Parliament.
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Chancellor of the Exchequer George Osborne holds Disraeli's original budget box as he leaves 11 Downing Street for Parliament.

The UK is as good a place to start as any. The government there has so far placed the strongest emphasis on what is inaccurately termed “austerity” rather than on “spending,” in order to get the economy back on track. Given that investors have been paying close attention to sovereign credit ratings since the crash, and that the UK’s borrowing costs are the cheapest they could be right now with the country’s AAA rating, this makes a lot of sense. It isn’t the whole picture though. The Chancellor’s predecessors from another era, the great “supply-side” reformers Geoffrey Howe and Nigel Lawson, would probably suggest that he needs to pay as much attention to the labor market and the complexities of taxation policy, in that order, as he does the budget deficit.

Incentivizing companies to take on more staff is the least painful way to reduce unemployment, and a government can do this by freezing employer payroll taxes for all new hires for, say, one year. Unlike the additional measures taken in the US, this doesn’t cost any money, it’s just an opportunity cost foregone. And there are some lessons from across the Atlantic for Osborne to ponder. US employment creation has been impressive the last few months—last week’s non-farms payroll number being the latest report to outperform even optimistic forecasts. If this performance continues to the end of the second quarter, there should be no doubt that the US economy is in recovery mode, which is timed handsomely for President Obama’s re-election hopes.

The “spending versus austerity” debate has a nice counter to the UK in the US. The US jobs performance has been assisted by an employee payroll tax cut, by dint of a small reduction in social security contributions. This is spending to create jobs, but in a more direct and effective way than paying people to dig ditches. This has a cost, but could easily be afforded in the UK through, for example, the £5 billion ($7.85 billion) that would be saved by pulling the expeditionary army out of Afghanistan in 2013 instead of 2014.

The point of the above is merely to illustrate that the answer to our question is “both.” The US has one advantage over all other borrower countries in that it will always find buyers of its debt (its AAA rating is almost a formality). In recent months, US T-bills have traded at negative yields, and are still in single basis-point figures. But US policy recognizes that reducing unemployment is a key priority, and lowering the level has many knock-on benefits in society. It also raises tax receipts. Prioritizing jobs, in a meaningful way, by incentivizing companies to hire more staff, should be every finance minister’s mantra, including Osborne’s next week.

The author is Professor Moorad Choudhry is Treasurer, Corporate Banking Division, Royal Bank of Scotland.

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