Opening Remarks

Lucky for Obama, U.K.'s Cameron Is Embracing Austerity First


For such charismatic guys, Barack Obama and David Cameron make an awfully chilly pair. At the first White House news conference between the American President and British Prime Minister, their divisions ran deeper than whether beer should be served warm or cold. Cameron acknowledged the legitimacy of U.S. anger over BP's (BP) oil catastrophe while defending the company's right to life. (Obama wants to keep BP alive, too—so he can extract cleanup costs.) Obama praised Cameron's condemnation of the Scottish Parliament's decision to free Lockerbie bomber Abdel Basset Ali Al-Megrahi, but in tones that suggested the U.K. still has a long way to go to make amends. Their real flash point, though, concerns economic priorities.

Obama, widely seen as governing from the left, is struggling in the polls because of it. Cameron will remain British Prime Minister only so long as he can reconcile his right-wing instincts with the more centrist approach of his Liberal Democrat coalition partners. Yet both are coming to the same realization: Plugging their economies into the life-support system of central bank liquidity and massive government stimulus packages was the easy part. The tough question is how long their governments should stand in for a private sector too nervous about the future to invest and hire. With the world economy threatening to slide into a double-dip recession, both the U.S. and the U.K. are nevertheless talking about fiscal austerity. The only good news for Obama is that Cameron is going first.

If his nerve holds, Cameron is about to embark upon an unprecedented experiment. He has told government departments to brace for spending cuts of as much as 40 percent as he seeks to shrink both the U.K.'s record budget deficit and a public sector that now accounts for nearly 20 percent of all U.K. jobs.

With the biggest deficit among Group of Seven nations and the worst looming shortfall in Europe this year according to European Union forecasts, the U.K. doesn't want to be the next Greece. Less than a minute into a June 22 budget speech, Chancellor of the Exchequer George Osborne suggested that bond vigilantes are driving U.K. economic policy. "Questions that were asked about the liquidity and solvency of banking systems are now being asked of the liquidity and solvency of some of the governments that stand behind those banks," he said. "I do not want those questions ever to be asked of this country."

Austerity Debate

Most governments, with apologies to Saint Augustine, would offer a prayer to "make me austere, but not yet." As Marco Annunziata, the chief economist at UniCredit Group in London, puts it: "The austerity debate is now not about whether fiscal tightening in advanced economies is necessary, but on when it should begin in earnest."

That's why policymakers around the world will be watching Britain—especially those at the Federal Reserve, which is not yet ready to follow Osborne's lead. The Fed's colors are still tied to the mast of maintaining stimulus and keeping borrowing costs as close to zero as possible. At its June 22-23 meeting, the Fed said it would even "need to consider whether further policy stimulus might become appropriate if the outlook were to worsen appreciably."

Fed Chairman Ben Bernanke is concerned that what John Maynard Keynes dubbed the paradox of thrift may kick in if austerity packages are adopted too swiftly and severely. The 20th century British economist, whose work provided much of the blueprint 21st century governments used to drag their countries out of recession, argued that while it makes sense for one or two constituents of a community to save prudently, growth collapses if all of the members simultaneously abstain from spending. Too many governments curbing spending and raising taxes in parallel would snuff out the nascent recovery.

Asked about the U.K.'s austerity plans with Cameron at his side, Obama sounded reliably Keynesian, repeating a warning he had delivered to the Group of 20 nations in April: The world, he said, cannot rely on "an economic model in which the U.S. borrows, consumers in the U.S. borrow, we take out home equity loans, we run up credit cards to purchase goods from all around the world. We cannot alone be the economic engine for the rest of the world's growth." No wonder Obama delivered the line "we speak a common language most of the time" without discernible humor.

He knows that neither the American nor the British consumer is ready to spend. Consumer confidence has dipped, slumping in July to its lowest level in a year in the U.S. and worse than even the most pessimistic forecast of economists. Confidence in Britain is at a six-month low. The housing market remains petrified in both nations. Without an improvement in consumer trust, government aid can't be removed without risking a relapse.

Cameron's Plan

Yet that is Cameron's plan. He has a window of opportunity to push it through by claiming to be cleaning up the mess left by Gordon Brown's administration (just as Obama blames George W. Bush every chance he gets). U.K. government employees, long willing to accept lower wages in return for job security and lucrative pensions, are horrified at the ax heading their way. The Office for Budget Responsibility, a unit created by Cameron to give spin-free assessments of the economy, is predicting 610,000 job cuts in the public sector during the next five years—11 percent of the total public workforce. That would leave 4.92 million workers on the government payroll out of a total of 30 million employed Britons. With so many job cuts, Cameron could find himself coping with strike action on a scale not seen since Margaret Thatcher neutered the nation's private-sector unions.

The banking industry, meanwhile, is crying foul at the prospect of bonus caps and a top income-tax rate that will climb to 50 percent from 40 percent. Threats to leave for Switzerland may prove more than empty.

Cameron, though, has only detailed about half of his planned spending cuts, leaving most of the electorate in the dark about where the ax will fall and his coalition partners nervous about their reelection prospects once their constituents recognize the Faustian pact they've made in exchange for a handful of ministerial positions.

To have any chance at success, he'll have to keep Deputy Prime Minister Nick Clegg, whose Liberal Democrats have enough Parliamentary seats to hold the balance of power, on his side. But Clegg, who agreed to Cameron's icy austerity plan over the objections of many Lib Dem members, has seen his support among voters slump by five percentage points, to 16 percent, since the budget details were released, according to polls by ICM Research and YouGov. Sixty percent of respondents opposed plans to increase the U.K. sales tax to 20 percent from 17.5 percent, the ICM survey showed.

Rating Risk

The path Cameron is charting is so arduous, and public opposition is likely to become so intense, that rating agency Standard & Poor's isn't convinced he can deliver and has even said it may cut the U.K.'s credit rating. "A number of large and politically challenging spending decisions are still to be made," it said on July 12. "There is still a material risk that the U.K.'s net general government debt burden may approach a level incompatible with the 'AAA' rating."

The rating agencies have been working their way through the list of profligate EU governments in recent months, starting with the worst offender, Greece, and then cutting the credit grades of other indebted nations, including Ireland, Portugal, and Spain. If Cameron blinks, the U.K. may be next. If he forges ahead, there is a real chance that Britain returns to a recession. Neither scenario is cheery—and neither is beyond imagining for the U.S. Which is why Obama, as he thinks long and hard about whether to embrace austerity or risk the embarrassment of the U.S. losing its AAA rating, is already adopting another durable British invention: the stiff upper lip.

Gilbert is the London bureau chief and a columnist for Bloomberg News.

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