The secret to the American recovery

From trillion-dollar deficits to unprecedented spending cuts


Kevin Lamarque/Reuters

About four years ago economists and investors took to viewing America and Britain as lab rats in a vast, real world experiment. The two countries were by no means willing subjects. (What lab rat ever is?) Crawling out of a deep global recession, each nation was desperate to find a path to growth. For observers peering into the maze, however, the hope was to finally settle one of the most entrenched debates in economics: Is it better for governments to boost spending to stimulate an economy, as President Barack Obama regularly argued, or should countries that lived beyond their means pursue austerity to get their fiscal houses in order and restore investor confidence? The latter was Prime Minister David Cameron’s aim.

It was rare for two large, well-developed economies take such divergent paths simultaneously, and Gary Becker, a Nobel prize-winning economist at the University of Chicago, told me in 2011 that within two years he expected to see preliminary test results.

And yet a funny thing happened along the way: America became a pillar of austerity.

Hold on one minute, you might be saying. America is an over-entitled, fiscal basket case. The country’s spending is out of control, the public sector is hopelessly bloated and households are so deep in debt they’ll take decades to recover. America is like Greece, only with more cheeseburgers and handguns.

It might have looked that way at one time, but a closer examination of the data shows America has taken huge strides to reverse its spendthrift ways. Let’s start with the trillion-dollar deficits that dominated headlines after 2009. You’ll notice they’re absent of late. In the last year, America’s deficit, once as high as $1.4 trillion in 2009, dropped nearly 40 per cent to $680 billion. Measured another way, relative to the size of America’s economy, the deficit is expected to fall to three per cent of GDP in the next year, from 10 per cent in 2010—the sharpest fiscal adjustment America has witnessed since the 1970s. While belt tightening in the U.K. continues apace—the Chancellor of the Exchequer George Osborne warned this week Britons should prepare for “a year of hard truths”—the red ink has been slower to vanish. (For charts on the deficit fight in the U.S. and U.K., and how Canada compares, check out the Econowatch blog.)

Higher taxes in both countries helped efforts to tame deficits, but American spending cuts have been almost unprecedented: Government spending in the U.S. has declined right through the recovery and is roughly 15 per cent lower than where it would have been at this stage in America’s seven previous recoveries. That spending restraint has meant an avalanche of pink slips for government workers. The number of public sector jobs is at its lowest point since 2006, down nearly four per cent from 2009—a major reason, it must be said, for why America’s unemployment rate has been slow to drop.

America’s households have also waged their own austerity war. According to David Rosenberg, chief economist at Gluskin Sheff, consumer debt relative to disposable income has shrunk to where it was a decade ago. “The entire massive 2002-07 credit expansion has been reversed,” he wrote in a report. “The household sector is in a far better financial position to contribute to economic activity.”

Of course, America’s austerity drive was in no way a policy initiative on the part of the Obama White House. Rather, it was a by-product of a bloody slugfest toward compromise with the Republican-held House, a fight that took the global economy to the brink multiple times. (See: debt ceiling crisis, government shutdown, fiscal cliff, sequestration, debt ceiling crisis II.)

None of this is to say America doesn’t still have serious fiscal challenges ahead. Its debt level continues to grow at a worrisome rate. Without entitlement reform, deficits are forecast to explode in a decade. And if interest rates rise, debt charges threaten to undo all the progress made to date.

And yet here we are, with an American economy the OECD expects will grow 2.9 per cent this year and 3.4 per cent in 2015, compared to 2.4 per cent and 2.5 per cent in the U.K. “What the [U.S.] economy has had to endure is a balance sheet adjustment process of epic proportions,” says Rosenberg. “We had a recovery held back by intensive balance-sheet repair.”

What does all this mean for the Great Economic Experiment? Despite America’s more aggressive assault on its deficit, its economy is growing faster than Britain’s. The stock market bull run of the past three years, it can be argued, also reflects growing confidence among investors that austerity did work, painful though it’s been, and that America won’t tumble into its fiscal gap. And yet, many economists argue spending cuts have done real damage, that the economy would be further ahead if they hadn’t happened.

Like most matters economic, there will probably never be agreement. But it’s time to put the idea that America is a hopeless deadbeat to rest.

Chop chop: Cameron hailed austerity, but America has undertaken far deeper spending cutsdeficits


The secret to the American recovery

  1. Neither country went big on ‘austerity’ or ‘spending’…because they make no difference overall. It’s social change that matters….which is why Japan is spinning it’s wheels all these years later.

    But the US now has healthcare, and the UK has booted bennies. Both countries fostered investment and a boom attitude.

    I know it’s nothing you can count on a balance sheet….but it’s what creates needed changes.

    • Did ya get them off of a corrupt South American socialist website too by any chance?

  2. So the US Dems and Reps blunder into potential recovery, while the BritCons just keep on blundering. Who’d a thunk it! Maybe everyone ought to get themselves a tea party.

  3. 1) A lot of that spending reduction is just the end of useless unproductive spending on wars overseas that are in the process of being wound down.

    2) The size of the deficits are also being suppressed because of the massive monetary accommodation by the Fed and the BOE, interest rates held at 0%, and trillions in quantitative easing (money printing) which are suppressing interest rates across the entirety of the yield curve. This means that interest rates on ballooning national debts means the size of interest payments on the national debt do not reflect what the payments would be if monetary policy were normalized.

    3) And well some of the money printing from QE does leak out into the real economy leading to artificially increased tax revenues.

    i.e. The size of QE has exceeded the size of the US deficit for the past year. So fairly extreme defacto debt monetization is occurring.

    This is hardly austerity.

  4. Spending cuts?

    You’re actually saying that moving away from a deficit that is 10% of GDP is austerity?

    The debt rising from 60% to 90% of GDP is austerity?

    Walking away from the edge of the cliff is austerity? Averting fiscal disaster is austerity?

    The US fiscal disaster makes Canada’s situation in the 90s look like a picnic.

    How much does the Democratic Party pay for this propaganda?

  5. xxx

  6. Austerity = billionaires telling millionaire politicians that poor workers are “too greedy”

  7. Trillion dollar deficits? Don’t give Ontario’s Liberals any ideas, ok?