Global Economic Crisis

According to the United Kingdom’s Office for National Statistics, the British economy contracted by 0.5 percent in Q4 of 2010. The ONS data came as a deep shock to the British economic and political establishment.  Expectations were that the UK economy would continue a pattern of weak growth during the last three  months of last year. By any stretch of the imagination, this is not good economic news.

The UK’s prime minister, David Cameron, already has his spin-masters working overtime. The official explanation is that “the weather” caused the contraction in Q4. However, even if the weather is taken out of the picture and the ONS data adjusted accordingly, the Q4 result would still show no growth. Undoubtedly, the UK coalition government is hoping that the ONS will eventually “revise” the Q4 number upwards. However, no matter how the politicians spin the news, the UK economic crisis remains intractable.

What is especially distressing about the ONS number is that the draconian spending cuts that have been formulated by Cameron’s government had not yet kicked in during the period in which Q4 economic statistics were being tabulated. With the British economy seemingly on the verge of a double-dip recession, the sharp cuts in public spending will prove to be a powerful pro-cyclical policy measure. The likely result is a renewed recession, resulting in a drop in tax receipts for the British government, ultimately defeating the stated purpose of the sharp fiscal cuts. In essence, the UK economy is caught in a dangerous fiscal trap, which the most recent ONS data for Q4 clearly illuminates in all its dark reality.

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As expected, George Osborne, Chancellor of the Exchequer in the new British coalition government, unveiled an emergency budget aimed at tacking the UK’s massive structural fiscal deficit. It is being described as the toughest UK budget since the age of austerity that followed in the immediate postwar period after the Second World War. It features a rise in the VAT to 20%, increased income and capital gains taxes, public service wage freezes and across the board programmatic budget cuts. The question that stands is this: will it work?

In my view, as explained in my book (Global Economic Forecast 2010-2015: Recession Into Depression) the United Kingdom, as with many other advanced economies, is in a fiscal and demographic trap. It’s national debt has skyrocketed to almost 70% of GDP; even with the Osborne budget cuts, continuing deficits will send this ratio towards 100% of GDP in the near future. With an aging population, meagre real economic growth at best and an economy that, like a heroin addict, has become dependent on its fiscal deficit fix, the UK economy is in such a trap.

Cut public spending dramatically, warn the critics, and the British economy will enter a double dip recession, and they are right. A renewed economic contraction will diminish tax revenue, largely defeating the purpose  of budget cuts and increased levels of taxation. However, continuing the neo-Keynesian debt folly is even more calamitous, for it will inevitably lead to a total fiscal collapse of the UK.

The real lesson is that the wild spending spree engaged in by policymakers in response to the global economic and financial crisis was flawed, and should have been curtailed before public debt to GDP ratios exploded to unsustainable levels. It is now too late to avoid severe economic pain. The only option left is determining which path will incur the least suffering on society.

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