Britain's plunge back into recession is fuelling fears that harsh austerity measures are deepening the country's economic woes, exacerbating Europe's debt crisis and choking the global recovery.
The ailing British economy shrank 0.2 per cent in the first quarter of the year, after falling 0.3 per cent in the fourth quarter of 2011, according to data released Wednesday by the Office for National Statistics. The consecutive two-quarter contraction marks a technical recession, Britain's first of the double-dip variety since the 1970s. The surprising drop confounded forecasters, who had expected flat or slightly positive growth.
The reading on Britain's economy, the first of the industrial countries to report on the first quarter, doesn't augur well for other governments that have embraced stiff budget cuts. The backlash against such policies has increased dramatically in countries whose deteriorating economies stand as stark evidence for economists who have long argued that it is not possible for governments to cut their way to stable growth.
The shrinking economy puts added pressure on British Prime Minister David Cameron, whose embattled coalition government was the first in Europe to embrace belt-tightening, in the belief it would restore confidence in the markets and encourage investment and growth in the economy. The austerity has won plaudits from the bond world, but has not translated into economic gains.
Mr. Cameron placed the blame for the latest slump on European woes. "Just as you see now recessions in Denmark, in Holland, in Italy, in Spain, that is what is happening in the continent that we trade with. What is absolutely essential is we take every step we can to help our economy out of recession," he told parliament. The European Union accounts for more than 50 per cent of British exports.
In response to worsening conditions in continental Europe, the backlash against austerity has been building rapidly, fanned by rising opposition politicians such as France's François Hollande. The Socialist leader edged President Nicolas Sarkozy, a staunch supporter of German-led fiscal austerity, in the first round of voting Sunday in the presidential election and is favoured to win the runoff May 6.
"[Mr.]Cameron and [Chancellor of the Exchequer George]Osborne insist that they will not change course, which means that Britain will continue on a death spiral of self-defeating austerity," famed U.S. economist Paul Krugman, a fierce opponent of budget-slashing policies in the teeth of strong economic headwinds, wrote on his popular New York Times blog.
The "austerity was supposed to work by inspiring confidence," Mr. Krugman said. "Where's the confidence? Basically, the expansionary aspect should already have kicked in; it's all contraction from here."
Many economy watchers and the Bank of England doubt that Britain has actually slipped back into recession, citing a stabilizing labour market, more positive signals from purchasing managers in construction and manufacturing, better retail sales and other data not included in the first GDP reading.
"My suspicion is that this time next year, it [the first quarter of 2012]will show modest growth. But by the time that's reported, it will have all been long forgotten," said Howard Archer, Chief European and British Economist with IHS Global Insight in London.
Markets, too, largely shrugged off the news that Britain posted its second quarter of economic contraction in a row – and its fourth negative quarter of the past six. The British pound slid only slightly from a seven-month high against the U.S. dollar and also declined against the euro, after reaching a 20-month high on Tuesday.
European Central Bank head Mario Draghi supports tough fiscal discipline. But he is now also urging European leaders to adopt a "growth compact" to go along with the German-led "fiscal compact" signed in March – though not yet ratified.
Mr. Hollande has made the compact a key theme of his campaign, vowing to reject ratification unless the terms can be renegotiated to encompass policies to stimulate growth.
But the central banker is calling for labour market and other structural reforms that would promote economic expansion – not a return to heavy deficit spending. "From Mr. Hollande, it's good old-fashioned Keynesian stimulus of the economy," said Carsten Brzeski, a senior economist with ING in Brussels.
Even German officials are talking up growth in an effort to fend off the critics of their get-tough policies being imposed throughout the 17-country euro zone. "Talking about fiscal discipline does not mean that Germany is, let's say, more or less a kind of consolidation Taliban," Deputy Finance Minister Thomas Steffen told a financial conference in Berlin. "We do not think it's all about fiscal consolidation, we very much believe that the euro zone also needs more growth."
The EU's executive commission forecasts that the euro-zone economy as a whole will contract by 0.3 per cent this year, but recent surveys of purchasing managers indicate that number may be optimistic.