Colin Barr

Following the money in banking, economics, and Washington

U.K. shows limits of austerity

January 25, 2011: 1:00 PM ET

Just in time for tonight's big speech comes a reminder of the limits of austerity.

The U.K. economy posted a 0.4% fourth-quarter output decline, stunning economists who had expected to see gross domestic product rise 0.5%. Perhaps half the shortfall came from bad weather, but the news in any case was "shockingly bad," economists at Capital Economics in London said.

Bad show, mate

The shortfall is noteworthy because Great Britain, unlike the United States, has wholeheartedly embraced austerity, in the form of spending cuts and tax increases – much to the applause of sober-minded observers like the rating agencies.

But Tuesday's bad news highlights the risks an austerity program can present to a weak economy – a message President Obama himself has sent once or twice in his day, against the increasingly strident cutback calls of the Republicans.

The U.K. numbers may give Obama a bit of solace as he prepares to present his plan for how America can work its way out of its debt-addled mess.

Granted, the United States has hard work ahead in breaking its spending addiction. But Obama's case for moderation should come easier now that all can see how even the star pupil in the austerity class is struggling to keep his marks up.

"It seems pretty clear from the GDP figures that the recovery in the U.K. is in trouble," write Jonathan Loynes and John Higgins of Capital Economics.

The growth disappointment comes six months after U.K. prime minister David Cameron this summer presented a budget calling for cutbacks some observers described as "eye-watering."

His spending cuts and tax increases -- including a rise in the value-added tax to 20% from 17.5% -- surely didn't cause the U.K.'s latest setback, mind you. But they won't make the next year any easier.

Howard Archer of IHS Global Insight said he expects U.K. growth to be just 1.5% this year, down from his previous 1.8% forecast.

"Given that the contraction in GDP in the fourth quarter occurred even before the fiscal tightening had really kicked in, it reinforces already serious concern over the economy's ability to grow significantly in the face of the spending cuts and tax hikes that will increasingly bite as 2011 progresses," Archer said of the U.K. numbers.

Nor will the latest developments give the money wonks at the Bank of England much room to raise interest rates to combat surging inflation, which recently hit 4%.

"The data will surely cause the Bank of England's Monetary Policy Committee to pause for thought before considering any rate rise to ward off current inflationary pressures," said Chris Willamson of data provider Markit.

The bad news is timely for President Obama as he prepares tonight's state of the union address, because Republicans in Congress have been calling for cuts here too. They say they want to slash federal spending to put more money in people's pockets and boost job growth.

But Obama has been making the case that it won't pay to cut spending sharply now, at a time when unemployment is near 10% and the path back to healthy employment levels will surely take years.

The risk of not taking enough action, of course, is the debt crisis that Alan Greenspan and others have been warning about. That's not to be scoffed at.

But Tuesday's news offers a timely reminder that there is no way out of this crisis, whether via austerity or via what the administration might call tong-term investment, that is going to be either fast or easy.

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About This Author
Colin Barr
Colin Barr
Senior Writer, Fortune

Colin Barr has covered finance for Fortune.com since November 2007. Previously he was a writer and editor for TheStreet.com, winning a 2006 Society of American Business Editors and Writers award for "The Five Dumbest Things on Wall Street," and for Dow Jones Newswires. He is a 1991 graduate of Penn State and lives in Port Washington, N.Y., with his wife Meena Bose and their two kids.

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