We share so much with our British friends across the pond. Not just language, but core values from human rights to rock ‘n roll. Unfortunately, we share the same economic crisis as well: out-of-control budget deficits threatening to grow larger unless radical action is taken.

So how do you explain how our two countries have developed such radically different approaches to our respective fiscal messes? The U.K. has slammed on the brakes when it comes to government spending, while the U.S., through a recent and massive fiscal stimulus, stepped on the gas. A decade from now, one of these approaches will have looked brilliant while the other foolhardy. But which one?
Results in the Near Term

Roughly two years after U.S. stimulus was enacted, its major stock indexes, including the S&P 500, have doubled. Part of that gain can be explained by the fact that the U.S. economy appears to be getting healthier. But some of that growth is also almost certainly attributable to Federal Reserve efforts to jumpstart economic activity through the policy known as 'quantitative easing.'

[InvestingAnswers Feature: A Primer on Quantitative Easing: What Is It and Will It Save the Economy?]

Meanwhile, the U.K. has largely shunned stimulus efforts and has gone in the opposite direction -- it's already laid out plans to sharply cut government spending. That strategy has led to a great deal of social unrest, making the U.S.-based Tea Party rallies look tame in comparison.

So has the U.S. economy benefited from their more aggressive fiscal approach? Considering the economy was shrinking at a fast pace when the stimulus plan began, GDP growth of around 2% over the last five quarters has to be seen as a positive outcome. In contrast, the U.K. economy showed a much more modest rebound in the summer of 2010, and GDP actually slipped back into negative territory in the fourth quarter of 2010 (see Figure 1). The British stock market hasn't kept pace with its American counterpart, either. The U.K.’s main index, the FTSE 100, has risen 50% in the last two years, half the gain of the U.S. market.

Figure 1. U.S. GDP vs. U.K GDP from Q1 2009 to Q4 2010

U.S. GDP vs. U.K. GDP 2009-2010

It's important to note that GDP growth, both now and later, is the key factor behind the Obama administration’s long-term deficit reduction goals. Rising economic activity helps boost government income because higher profits theoretically lead to higher tax collections. Indeed that was the case in the late 1990s when the Clinton administration was able to get the budget into the black thanks to robust economic activity.

In contrast, slow economic growth in the U.K. economy is leading to revenue shortfalls -- a serious problem for that government. The expected payoff from belt-tightening measures has been sharply eroded. Lower-than-expected government tax receipts means that the U.K.’s budget will still run a £150 billion ($245 billion) deficit this year vs. a U.S. budget deficit of about $1.5 trillion. The U.S. economy is five times larger, so the U.S. budget deficit is roughly 20% larger than the U.K.’s, adjusted for relative economic size.

U.K. government officials are betting that a more manageable government debt load will (eventually) inspire companies to invest in the economy, creating jobs and higher GDP growth. That plan hasn’t panned out yet, but it’s really far too soon to pass judgment. The psychological impact on business from government policies is felt over years, not quarters.

Eliminating deficits is only a first step. Bringing down those massive debt loads will be the hard part. As of now, the total debt owed by the U.K. government stands at nearly £900 billion ($1.475 trillion). The U.S. total debt stands at over $14 trillion, with net debt just below $10 trillion when accounting for surpluses in Social Security and other trust funds.

Who Chose the Right Course?

Back to our initial question, which approach will prove most successful? Economists at Merrill Lynch predict that the U.S. economy will grow 2.6% in 2011 and 3.0% in 2012. They think the U.K. economy will grow an anemic 1.5% this year, and an improved 2.6% in 2012. And whereas the U.K. budget ran a 9.7% deficit in 2010 (the government spent $109.70 for every $100 it took in), that figure is expected to drop to 6.2% by 2012. Simply put, the U.K.’s economy will need to grow at a much faster pace for the benefits of belt-tightening to have an impact.

Common sense tells you that fiscal discipline is the only response to the mess created by fiscal profligacy. If both of these countries’ economies were growing at a similar rate, then you could argue that the British approach is the right one, as the budget would likely move back into balance at a faster rate. But as noted earlier, that’s not the case. British growth remains quite anemic, and it may under-cut any benefits that belt-tightening would generate.

Why Deficits Matter

Back in 2001, Dick Cheney famously said that “deficits don’t matter.” He was wrong. They do matter.

As we saw with many households during the recent boom, when you live beyond your means, the consequences can be dire. That’s why the U.K.’s efforts should be applauded. But that makes it more difficult to accept that by a variety of measures, the recent decisions by the U.S. to stimulate the economy (through both Federal spending and lax interest rate policies) has proven to be the better choice. If the U.S. had been posting economic growth rates that the U.K. is seeing, the U.S. budget woes would be even more severe. It will likely take many years before a verdict is in, but thus far, the U.S. approach appears to be savvier.