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Scorched Earth: What the U.S. Can Learn from Deficit Reduction in the U.K. and Germany

If you want to see what the U.S. economy might look like following deep cuts in government spending, just gaze across the pond. Britain's GDP shrank 0.6 percent in the fourth quarter, which was even more than the initial forecast of a 0.5 percent dip. That's the U.K.'s biggest quarterly drop in growth since the second quarter of 2009, right in the depths of the Great Recession.

Ain't austerity grand? In October, the U.K.'s newly elected Conservative government took a meat cleaver to public spending in hopes of boosting the economy. While it's premature to call that policy a dud, the latest growth figures can't be encouraging for Prime Minister David Cameron. The economy would've fared even worse without a quarterly uptick in government spending, which was required to offset a decline in consumer spending. And while unusually cold weather late last year may have had something to do with the spending pullback in construction, investment and other sectors, it's clear that growth in the U.K. is slowing:

"This is fairly worrying given we know about the wave of fiscal austerity that is now starting to hit the U.K. economy," said James Knightley, economist at ING.
Not springtime for Germany
Germany, too, is starting to suck wind after slashing its budget last year. In the fourth quarter, its economy grew a meager 0.4 percent, down from 0.8 percent the previous quarter. By contrast, U.S. GDP growth in the fourth quarter was 2.8 percent.

After Chancellor Angela Merkel announced the cuts, pundits here at home contrasted Germany's aggressive move to reduce its deficit with the Obama administration's preference for fiscal stimulus, framing it as a "natural experiment" in testing which approach was better. And when the German economy started to grow, deficit hawks quickly claimed victory for their side of the argument.

Not so fast, notes the NYT's David Leonhardt:

[I]t turns out the German boom didn't last long. With its modest stimulus winding down, Germany's growth slowed sharply late last year, and its economic output still has not recovered to its pre-recession peak. Output in the United States -- where the stimulus program has been bigger and longer lasting -- has recovered. This country would now need to suffer through a double-dip recession for its gross domestic product to be in the same condition as Germany's.
Germany's late-year fade doesn't bode well for the broader eurozone. Other countries in the region depend on a strong German economy to buy their exports. After GDP growth in the euro area rose to 1 percent in mid-2010, it had plunged to 0.3 percent by year-end.

And with the so-called PIIGS states -- Portugal, Ireland, Italy, Greece and Spain -- still struggling after their own round of budget cuts, a prolonged slowdown in private investment and spending across Europe would weigh heavily on even the continent's larger economies. In fact, it's already happening.

Consumer confidence is falling in Germany and France, which is likely to pinch spending. (Business Insider's Dian Chu points out that over the long-term these supposedly stronger states may be in deep trouble; see map below, courtesy of research firm Maplecroft, to see which nations are most at risk.) Add soaring gas prices stemming from the conflict in the Middle East and -- voila! -- austerity soon looks like anything but a panacea.

Lesson learned?
Leonhardt distills what this means for the U.S.:

That's the historical lesson of postcrisis austerity movements. The history is a rich one, too, because people understandably react to a bubble's excesses by calling for the reverse.... But no matter how morally satisfying austerity may be, it's the wrong answer.
Our problem is less that such policies are morally satisfying than they are politically expedient. It's also that people have a hard time distinguishing between the economic imperatives facing countries like Greece, which really is up the creek, from the more manageable challenges facing the U.S.

Still, it's not too late for Washington to recognize that draconian spending cuts -- whether in Europe or here at home -- will solve nothing.


Image from Flickr user photosteve101; chart courtesy of Maplecroft
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