While we’re cheering U.K. conservatives’ push for fiscal austerity measures right now, two economics professors from Dartmouth, David Blanchflower and Elias Papaioannou, think otherwise.
They believe harsh U.K. austerity is the wrong solution for a misdiagnosed problem… which could plunge the U.K. into a double-dip recession:
Proposing the same medicine in the UK as in Greece, though at a lower dose, seems a priori absurd, as the problems are fundamentally different because the two countries suffer from different pathologies.
The Greek crisis, they say, comes from a lack of competitiveness in the economy, high inflation, rampant tax evasion, and extensive corruption. Britain’s debt problem isn’t driven by these ‘structural inefficiencies’, but is rather a result of the recent financial crisis and the British government’s spend-thrift response.
Moreover, irrespective of the cause, debt metrics don’t even match:
Public debt in Greece is the highest in the euro area at about 120pc of GDP. The country also has one of the highest fiscal deficits in the OECD, at 14pc of GDP. The UK’s is 11pc.
In contrast, government debt to GDP in the UK in 2009 was 68pc –much lower than the euro area average of 79pc. While UK debt/GDP has increased over the past two years by about 20 percentage points, during the past decade it fluctuated around 40pc-50pc. The recent increase mainly reflects a rational Keynesian counter-cyclical policy in response to the global economic crisis.
U.K. government bond yields show far less distress than Greece:
These differences are reflected in government bond yields. Yields on long-term UK bonds are quite low, 3.58pc, very similar to US Treasury bonds. German bund yields are lower, at 2.56pc, reflecting the lower inflation expectations on the euro area.
And the U.K. doesn’t face the same refinancing risk:
In addition, only 20pc of UK debt matures in the next three years compared with 34pc for Greece. The ratio for the US is around 50pc and 40pc for Germany. So in contrast to Greece, the UK does not suffer at all from roll-over risk.
There is ‘zero chance’ that the U.K. will default on its debt, which is a far cry from the consensus view that Greece will default. Thus they imply that austerity and its negative economic impact would be tantamount to administering economic poison, just as the patient is starting to recover.
Our feeling is that the sooner the U.K. changes its unsustainable debt and spending path the better in the long-term, even if it means near-term economic pain, but you can read their complete view here and decide for yourself.