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Security was unusually tight to get into the Houses of Parliament in London last Tuesday. Although the guards gave me a nod of recognition, a new machine gun-toting colleague still frisked me thoroughly. That’s what I get for not wearing a tie, I thought. Taking a wrong turn to the right, I ended up near the entrance of the House of Commons, standing under the statue of the “Iron Lady,” Margaret Thatcher herself.
“It was a dark and stormy night”
That seemed particularly apt. I had been invited by a member of the conservative Tory party to take part in a discussion group in one of Westminster’s Committee rooms and chime in with my views on what they called “The Grand Experiment.” Earlier that day, Chancellor George Osborne had detailed the massive government spending cuts that set the United Kingdom firmly on the path of austerity. This stood in stark contrast to the “tax-and-spend” approach taken by his U.S. counterpart, Timothy Geithner.
“The Grand Experiment”
The “Grand Experiment” refers to the two competing approaches of governments around the world to the handling of the global economic crisis.
On one side stand Keynesians, who support massive government spending to kick-start their economies. Such was the approach taken by the Obama administration, with its seemingly endless spending and projections of trillion-dollar deficits. Although you’d have to look hard for any lasting effects of this approach on the U.S. economy, Keynesians like Paul Krugman, rather than admitting defeat, now want to double down their bets, insisting that the problem is, if anything, that government spending was too little.
On the other side stands the European Central Bank, whose leaders preach the gospel of austerity. Thanks to the successful example of Germany’s economy — which now boasts a lower unemployment rate than the United States — many of Europe’s peripheral countries like Ireland, Greece and Spain have agreed to take the bitter medicine of economic austerity. The spending cuts outlined by U.K. Prime Minister David Cameron and Chancellor George Osborne last week now put the United Kingdom firmly in the austerity camp.
Great Britain: Can’t Afford “Cool” Anymore
The Labor party’s expansion of government after the election of Tony Blair in 1997 was remarkably surreptitious. As recently as 2000, government spending accounted for only 34.75% of the United Kingdom’s gross domestic product (GDP). That figure exploded to a remarkable 45.53% in just 10 years. But David Cameron’s election as Prime Minister in May of this year sounded the final death knell of a tax-and-spend party in “Cool Brittania.”
Our group bandied about the details of the government’s cuts back and forth — 25% to 66% cuts in the Home Office, Ministry of Justice, the Department of the Environment and the Department for Communities and Local Government. The government also froze the salaries of public-sector workers for two years. With some elementary school teacher/administrators taking home 283,000 GBP ($447,000 last year) — a number that is on par with what an average Goldman Sachs employee is set to get this year — it was hard to shed crocodile tears for victims of austerity. And for all of the handwringing about government cuts — total government spending still will be 6% higher in nominal terms in 2014-2015.
The Canadian Model: The “Greece” of Its Day
What impressed me was how aware the British were of Canada’s experience 15 years ago, and how ready they were to learn from it. Meanwhile, I doubt more than a handful of U.S. Congressmen even are aware of what happened to our neighbors to the north.
In the mid 1990s, Canada was in worse shape than the United States. Government spending accounted for 53% of the economy. The country had lost its AAA-credit rating. A full 30% of its budget was going toward servicing interest costs. (The comparable interest-cost figure for the United States is 10%.) Canada’s debt-to-GDP ratio was a Belgium-like 120% — twice the current U.S. level. The Wall Street Journal called Canada “an honorary member of the Third World in the unmanageability of its debt problem.”
Yet in a few short years, Canada managed to engineer the most under-reported turnaround story among the world’s major economies. In 1995, Paul Martin, the finance minister for the national Liberal Party, prepared a budget that reduced program spending by 8.8% over two years. It reformed its welfare, “blank-check” system. Federal government employment fell by 14%.
The results of these reforms were nothing short of astonishing. The federal budget was balanced within three years. Federal debt was reduced to 45% of GDP. And instead of collapsing over the coming decade, Canada’s economy grew 3.3% per year — exceeding the developed-world average of 2.7%. And Canada never suffered from the sub-prime fiasco in the United States. Canadian banks were models of fiscal prudence.
The “Secret” of Economic Recovery: “Eat Less and Exercise,” Not “Magic Pills”
Austerity is a tough sell — especially if you want to get elected. After all, Keynesianism is a lot like a magic weight-loss pill. If it gives you a quick, painless and easy solution to your weight problem, why would you want to spend your time dieting and sweating in a gym?
The trouble is, magic pills never work as advertised. No pill ever really is going to replace good, old-fashioned diet and exercise — just like no amount of government stimulus can replace the pain of economic austerity. Like a hard work-out routine, austerity is painful in the short run. But if you want to get your economy back into shape, you can’t avoid it. Historically, countries willing to bite the bullet — like Canada and, to a lesser extent, Sweden — turned out to be among the most-resilient developed economies during the Great Recession.
Assuming the U.K. government sticks to its guns, that bodes well for both the British pound CurrencyShares British Pound Sterling Tr (FXB) and the U.K stock market iShares MSCI United Kingdom Index (EWU).
The bottom line? No country in history has ever taxed and spent its way to prosperity. It was good to see that my friends in the United Kingdom have stopped trying.