Oct. 27 (Bloomberg) -- Germany has clawed its way out of recession. France is growing again. The U.S. is starting to expand. Even Ireland, one of the countries worst hit by the credit crunch, isn’t contracting anymore.

And yet the U.K. economy keeps on getting smaller. Last week, 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 U.K. 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 U.K. 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 U.K. 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.

Household Debt

It isn’t hard to figure out why. The U.K. economy was puffed up on a wave of borrowing and speculation. According to Dublin-based Goodbody Stockbrokers, U.K. households have debts worth 183 percent of disposable income. That is the highest of any major economy. Even the U.S. 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 U.K. 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 14.8 billion-pound ($24.6 billion) 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 U.K. 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.

Ballooning Deficit

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 program 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 another 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 U.K. 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 program 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. But the U.K. didn’t need more debt-financed froth. It needed to start building new industries, and printing money isn’t helping that.

Unsustainable Debt

Two, get the budget deficit under control. At more than 12.5 percent of GDP, the U.K. 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. All it does is undermine confidence, and stop people spending now, because they know they will have to pay higher taxes further down the road.

Three, support the pound. A modern, advanced nation can’t devalue its way out of trouble. The idea that the U.K. is going to suddenly build lots of factories that compete with Eastern Europe and China on price is ridiculous. Britain can export plenty of things, but they are high-end, design and technology- intensive goods and services. Those products depend less on prices. There is no sign of exports picking up as a result of the pound’s collapse. All it does is destroy confidence.

Investment Destination

Four, cut taxes for business. The U.K. 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 U.K. is raising taxes. How is that going to help? Slashing corporate-tax rates to match the 12.5 percent charged in Ireland would send a clear signal that Britain was a place to invest again.

The U.K. went into this recession in terrible structural shape. It was too reliant on banking and financial services, its competitiveness had slipped, the state was expanding in size, and it was building up too much debt. Getting out was always going to be a long, painful slog. Instead, it has been going for the quick fix of an artificial stimulus.

The trouble is, it’s not a fix and it’s not working. The only way the U.K. can save itself is with radical changes.

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

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To contact the writer of this column: Matthew Lynn in London at matthewlynn@bloomberg.net.

Last Updated: October 26, 2009 20:00 EDT