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Britain's Houses of Parliament are pictured in London, on Februrary 4, 2010. (BEN STANSALL/AFP/Getty Images)
Britain's Houses of Parliament are pictured in London, on Februrary 4, 2010. (BEN STANSALL/AFP/Getty Images)

Britain once again 'sick man of Europe' Add to ...

ereguly@globeandmail.com

Alistair Darling will stay on as British chancellor if Labour wins the election, prime minister Gordon Brown said on the weekend. But whether it is Mr. Darling or a rival in the hot seat, this is a job that's not going to get any easier as the country once known as "Cool Britannia" is again being called "the sick man of Europe."

The last time the "sick man" moniker stuck was in the 1970s, when Britain was bled white by endless strikes, soaring unemployment and the collapse of the metal-bashing industries. It suffered the embarrassment of asking the International Monetary Fund to come to the rescue, a move which ultimately ended the Labour Party's reign and ensured the election of Maggie Thatcher.

Today the Opposition Conservatives, led by David Cameron, evoke the nasty image of the 1970s in an attempt to scare voters. Vote for the ruling Labour Party again - it has been in power since 1997 - and the country risks returning to the social and economic chaos that made life so difficult for the last generation, they say. The pre-election budget came last week; the election is expected in May and the polls suggest a hung Parliament.

The headline economic numbers seem to support the Tories' argument that Britain is on a Titanic run. Forget Greece; the most gruesome deficit-to-GDP figure in the European Union belongs to Britain. The 2010 deficit is expected to be 12.8 per cent. Last year, Greece's was 12.7 per cent and, thanks to a brutal austerity package, should fall to 8.7 per cent this year.

Between early 2008 and the autumn of 2009, GDP fell by 6.2 per cent.

Britain's six-quarter recession was the longest among the G7 economies. Borrowing as a percentage of GDP is forecast to be the highest among the G20 this year and government spending rose to 52 per cent of GDP - from 44 per cent in 2006

The pound has shed value rapidly. Many British banks would not have survived the financial crisis were it not for wholesale nationalizations. Britain's financial services industry, which had made the country one of the world's hottest economies in the 1990s and the much of the last decade, is shrinking. Industrial production fell 1.5 per cent in January even as it went in the opposite direction in most other European countries.

Britain's fall from grace has indeed been dramatic. When Prime Minister Gordon Brown was chancellor of the exchequer during the Tony Blair era, he boasted that Labour's management of the economy had been so proficient that the up-and-down economic cycle was gone. In his budget speech in 2005, two years before he replaced Mr. Blair as prime minister, he said "Britain is today in the longest period of sustained economic growth since records began in the year 1701."

In his budget speech last week, chancellor Alistair Darling took a decidedly less enthusiastic view of the economy than his predecessor had. "This budget takes place as the U.K. economy is emerging from the deepest global recession for over 60 years," he said.

Mr. Darling's budget was predictable. His aim was to rein in the deficit, but not so quickly as to plunge Britain back into recession (or eliminate Labour's chances of re-election). Borrowing next year is to fall slightly to £163-billion ($250-million) or 11.1 per cent of GDP. The deficit will then be halved to 5.2 per cent over four years. In short, Britain is swamped with debt and its triple-A credit rating is in jeopardy.

Fitch, the debt ratings agency, was underwhelmed by the budget, saying that, at best, it "inches in the right direction" while warning that "the projected path of deficit reduction still renders the public finances vulnerable to shocks given the uncertainty over the U.K.'s medium-term outlook."

The good news, if Mr. Darling's forecasts are to be believed, is that the worst is over and fairly strong growth is to come. His budget was written on the expectation of about 3.25-per-cent growth next year and 3.5 per cent thereafter. As an economy grows, tax revenue increases and expenditures (such as unemployment benefits) can come down. As a result, government borrowing can fall, allowing the debt-to-GDP ratio to stabilize.

The growth forecasts were dismissed as wishful thinking by some economists. But, historically speaking, they do not seem outlandish. In the four years after the last two recessions, growth was in the 3- to 4-per-cent range. And the rest of the EU is recovering. Their growth will propel Britain's and vice-versa.

Britain has a few more things going for it. The lower pound is boosting exports and Britain is still the world's sixth-biggest manufacturer. The financial services industry and housing markets have stabilized. Britain, unlike some of its EU neighbours, has flexible labour markets and a good record of productivity gains. As a result, its jobless rate, at 7.8 per cent, is among the lowest in Western Europe and lower than either Canada's or America's.

And while Britain's deficits are eye-watering, the country did start the recession with a debt-to-GDP ratio of only 50 per cent, compared with more than 100 per cent in Italy and Greece, giving it the flexibility to take on extra debt to get it through the downturn.

In essence, Britain seems well-positioned for recovery. The risk, and it's a big one, is rising interest rates. Almost every economist expects a rise in short-term rates over the next few years. If so, borrowing costs would rise for the government, for business, for consumers. This is the elephant in Britain's front room, one that could stomp the recovery to death.

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Follow on Twitter: @ereguly

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