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Wed 25 Nov 2009 04:00 AM

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Four ways to pull an economy out of recession

The US is starting to expand. Even Ireland, one of the countries worst hit by the credit crunch, isn't contracting anymore.

Germany has clawed its way out of recession. France is growing again. The US is starting to expand. Even Ireland, one of the countries worst hit by the credit crunch, isn't contracting anymore.

And yet the UK economy keeps on getting smaller. Last month, the government said gross domestic product dropped 0.4 percent in the third quarter. Expectations that Britain would join most of the rest of the world in staging a modest recovery turned out to be misplaced.

At this rate, even Iceland will pull out of recession before the UK does.

Prime Minister Gordon Brown keeps boasting he has the right policies to guide the country out of the woods. The truth is that they aren't working and they won't anytime soon.

Before it can recover, the UK needs a 180-degree change in direction. It must curb the budget deficit, support the pound, stop printing money, and cut taxes. This is now the longest recession since records began in 1955. While the rest of the world recovers, the UK hasn't. There is no sign of life in manufacturing, nor much in retail or services. The pound edges closer to parity with the euro every week: When it does, expect it to go into freefall.

It isn't hard to figure out why. The UK economy was puffed up on a wave of borrowing and speculation. According to Dublin-based Goodbody Stockbrokers, UK households have debts worth 183 percent of disposable income. That is the highest of any major economy. Even the US is only on 134 percent, while in comparable European countries, the ratios are far lower: In France, it is just 100 percent, and in Germany 99 percent.

The UK used to have a private debt problem. Now it has a private and a public debt problem. A collapse in tax revenue coupled with rising welfare bills to pay for the increase in unemployment has led to a widening gap between what the government receives and what it pays every month.

In September, it ran a £14.8bn ($24.6bn) deficit, the biggest ever recorded for that month. The half-year shortfall was the largest since records began in 1946, when the country still had the small matter of World War II to pay for.

The UK is disappearing under a tidal wave of borrowing. So far, the response from the government and the Bank of England has been straight out of the economics textbooks. Interest rates have been cut, the government has maintained spending and allowed the deficit to balloon, the pound has depreciated against the euro, with the tacit support of the Bank of England and the government, and a programme of "quantitative easing" has pumped cash into the system. The economy has been stimulated, stimulated and stimulated again. It has failed to respond.

So what's the answer? Yet more stimulus? More debt? Printing more money? Devaluing the pound by 30 percent? There are plenty of people who would argue for all those.

And yet, as any doctor will tell you, when the patient doesn't respond to the treatment, it's time to change the medicine. In reality, the UK needs a total change of direction. It needs to do four things right away to get it back on the road to recovery.

First, stop printing money. There is no evidence to suggest the programme of quantitative easing has done anything other than re-ignite another bubble. Stocks are soaring, the banks are minting money, and the property market, which never had a chance to correct, is starting to fizz again. It needed to start building new industries, and printing money isn't helping that.

Two, get the budget deficit under control. At more than 12.5 percent of GDP, the UK is running up debts at an unsustainable rate. Everyone knows that taxes must rise to pay for it, and services are going to be cut as well.

Three, support the pound. A modern, advanced nation can't devalue its way out of trouble. The idea that the UK is going to suddenly build lots of factories that compete with Eastern Europe and China on price is ridiculous.

Four, cut taxes for business. The UK used to be the low-cost destination in Europe. It has squandered that position, ceding ground to Ireland, Switzerland and just about everywhere else. That is crazy. It will take massive investment to build the new industries and companies to replace those that have been hit by the credit crunch. Right now, the UK is raising taxes.

The only way the UK can save itself is with radical changes.

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

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