Monday, October 25, 2010

US Economists on the UK Austerity

As you may have noticed, last Wednesday George Osborne announced the Comprehensive Spending Review, to much fanfare.

There are a few things to say in addition to linking up a couple of comments from US economists (against is Paul Krugman, for is Stephen Williamson).

The most important is this: When you're doing economics, try as best you can to separate what politics from economics. All politicians have a rather distorted view of economics: Tory ministers blame anything and everything on Labour, Labour ministers blame anything and everything on the Conservatives. Of course, they both have their economists, but the point is: Soon you'll be able to understand which bits each set of economists is ignoring to come to its conclusions.

For example, according to the Tories Labour is entirely responsible for the recession we suffered, and the budget deficit that has resulted. They support this with some assertions (apparently lax regulation from the FSA, not "fixing the roof when the sun was shining" whatever that actually means!). But what you will learn this year is that recessions happen: They are part of the natural cycle of the economy, and no amount of government action will solve that (Tories are right to laugh at Gordon Brown's comment years ago about ending boom and bust it's fair to say).

Additionally, government finances are a product of the economic cycle: In recessions, people are out of work and hence they don't pay taxes and instead claim benefits. So the budget deficit will worsen in a recession, especially the worst one in 70 years.

You'll learn next term about why economists worry about these cuts in spending (regardless of their views about how large the state should be). It's something called Aggregate Demand, and the Multiplier principle. The practical upshot is found in warnings by KPMG that the public sector cuts have a direct impact elsewhere because many small businesses rely on the public sector (councils, etc) for contracts, and hence many may go out of business as a result.

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