Many economists and others in the US are advocating a second fiscal stimulus program, believing that the close to $1 trillion in the Obama stimulus package was too modest. This call for another round of government spending is taking place despite the fact that about one third of the original package has not yet been spent, even though it is more than one and one half years since the package was signed by President Obama. Moreover, skeptics (including myself) about whether the US needs another spending package point out that leading economists in the President’s Council of Economic Advisers were far too optimistic about the effects of a big stimulus on unemployment rates. Instead of a predicted decline in unemployment due to the stimulus of more than 1½ percentage points, the total fall in seasonally adjusted unemployment has been only ½ of a percentage point from its peak of 10.2 percent.
Of course, perhaps other factors, such as the uncertainty about the business environment that Congress and the President created through their rhetoric, and also through their actual and proposed legislation, offset powerful effects of the fiscal stimulus itself in reducing unemployment. The unpleasant fact we economists have to face is that there is not strong evidence on the actual effects of governmental spending on employment and GDP. The usual claimed effects are generally based on predictions from highly imperfect theoretical models of the economy rather than from strong direct and clear evidence on the employment consequences of different fiscal stimuli.
This is why the UK’s experiment in reducing rather than raising government spending while Britain is still coming out of its serious recession is not only daring in the present economic climate, but it is also of great value in determining whether growing government spending is a valuable way to speed an economy out of a serious recession. In order to bring under control the large fiscal deficit of Great Britain that is well over 10% of the UK’s GDP, the Tory (coalition) government of David Cameron has proposed a fiscal tightening that amount to about 1.5 percent of GDP during each of the next four years. This will be accomplished by some increase in taxes, but mainly by cuts in spending on public services, public investments, and various benefits to families.
It is informative to contrast this British approach with that of the US. Federal government spending during the past few years increased to about 25 percent of GDP from a level that had been rather stable for a couple of decades, under both Democratic and Republican administrations, at close to20 percent of GDP. The federal fiscal deficit in 2009 was about 12% of GDP, and is expected (or hoped!) to decline in 2010 to about 8%. These are two of the highest deficit ratios in many decades. Essentially nothing is being done in Washington about these enormous deficits, aside from some proposals to raise taxes on the rich that will bring in very little additional tax revenue. Moreover, these proposals have been opposed by many Democrats in Congress as well as by most Republicans.
So which approach will be more successful: the British one that will sharply reduce government spending and fiscal deficits, or the American one that believes these deficits are necessary, and perhaps even too small, to get this country out of the recession? No one knows for sure about the short run effects on their respective economies of these very different approaches. Perhaps, and this is only a “perhaps” that I am by no means persuaded of, the British approach will cause more short-run harm to employment and GDP than will the American approach.
However, I am convinced that the British way is a far better way to improve the long-term growth prospects of an economy. That is, reductions in the bloated levels of government spending and fiscal deficits will do much more to stimulate the longer-term growth of the British economy, mainly by encouraging private investment and innovation, than will the present American approach. Perhaps in good part due to the gridlock in Washington that Posner discusses, this approach shows little desire to cut back on federal government spending, or on actual and projected fiscal deficits.