Britain Can't Spend Its Way Out of This Recession: Matthew Lynn

Commentary by Matthew Lynn

Nov. 4 (Bloomberg) -- The British could be forgiven for feeling gloomy right now with a tumbling currency, a shrinking economy, rising unemployment and a financial system that needed a government bailout.

Still, help is at hand. The government is now planning to spend its way out of recession.

In the past week, Prime Minister Gordon Brown has made clear his response to the most serious economic decline the U.K. has faced in more than a generation. In homage to economist John Maynard Keynes, Brown plans to spend and spend, casting aside his own rules on debt and launching big infrastructure projects.

By stoking demand, the aim is to avert a long recession.

He will be disappointed. At best, the final splurge of government spending will prove to be irrelevant. At worst, it risks turning a bad situation into a catastrophe.

The U.K. depends on the global capital markets to stay afloat. Scare away international investors and the country could turn very quickly into another Iceland. There is no doubt the U.K. is slipping into deep trouble.

``The prospects for the U.K. economy are grim, with a fairly severe recession starting to unfold,'' Michael Saunders, an economist at Citigroup Inc. in London, said in a note to investors last month. He predicts the economy will contract by 1 percent next year. Yesterday the European Commission made the same forecast.

Arbitrary Rules

The government is getting out its checkbook. Last week, Chancellor of the Exchequer Alistair Darling said the rule that limits public debt to less than 40 percent of gross domestic product would be waived.

``To apply these rules rigidly in today's changed conditions would be perverse,'' he said.

Maybe so. But once you start picking and choosing when the rules apply, they aren't rules anymore.

``The responsible course of action is more borrowing for the investment that is necessary both now and for the longer term,'' Brown told an audience of economists and businessmen last week.

But is more spending really ``responsible''?

Interest rates in the U.K. are still 4.5 percent, higher than in the euro area and the U.S. There is still plenty of scope for monetary policy to stimulate demand. There is no reason interest rates shouldn't be cut to 1 percent, or lower if necessary. There's a case for a public-spending increase when borrowing costs are close to zero, and can't go any lower. Yet Britain is a long way from that point. If you use that weapon now, you won't have it if you need it later.

Nervous About Future

Next, people know that borrowing today has to be repaid tomorrow. That means taxes will soar. As debt levels rise, consumers and companies will save more to help pay for higher taxes down the track. Whatever boost you get from higher government spending will be lost. And if it makes businesses nervous about the future, and encourages even more of them to quit the U.K. for countries with lower corporate taxes such as Ireland, it could turn a mild recession into a depression.

Worse, all that extra spending will hurt the currency. The pound fell as low as $1.53 on Oct. 24 compared with more than $2 earlier in the year. The U.K. is dependent on foreign finance since it runs huge trade and public-sector deficits. If public finances spiral out of control, global investors may take flight, and bail out of sterling. If that happens, Britain could end up like Iceland. It is hardly a risk worth taking, particularly when confidence in world capital markets is already so fragile.

Tax Cuts

Finally, this is a global recession. The U.K. relies more than most countries on world trade, so it will be one of the most affected. An extra few billion pounds spent on roads or other public works won't make any difference.

The polls suggest many British have already seen through the arguments for more public spending. The Taxpayers' Alliance said last week in a poll that 59 percent of voters would rather have lower taxes than higher public spending. Only 18 percent wanted the government to increase its outlays.

The U.K. spent its way into trouble. It can't spend its way out again. Taxes have risen too high, and debt has soared out of control. The nation needs to pay down its obligations and lessen its dependence on financial services. There is no reason it can't make that transition with hard work and some belt-tightening.

A final splurge of public spending will only postpone that adjustment and create a real risk of economic disaster.

(Matthew Lynn is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: Matthew Lynn in London at matthewlynn@bloomberg.net.