In the past two weeks I have listened to two leading commentators on the economy and you might want to finish your breakfast before reading this. First Vince Cable, the Liberal Democrat spokesman on the economy addressed a dinner organised by ITNEA, a network of Chairmen and NEDs of quoted IT and technology companies. He was in his usual downbeat style, long on analysis, which I imagine he perfected as an economist at Shell, but short on solutions. I think he is hoping for a hung parliament after next year’s election in which he is summoned to be Chancellor of the Exchequer in which case we can look forward to a tax the assets, soak the rich agenda which will drive the remaining noncoms away, prolong the recession and get the rest of us dusting off our passports.

I then attended a lunch with a group of local businessmen and listened to Matt Sinclair, Research Director of the TaxPayers’ Alliance. This lobby group is non-aligned politically but has come a long way in a short time to gain credibility with its analysis of the burden of a non-productive state. They deserve a listen to see just how far down this dangerous road we have come.

So two speakers from very different perspectives but with remarkable unity in their bleak analysis of the situation that the United Kingdom now faces. The national debt has doubled in three years. The borrowing requirement is increasing rapidly. The tax base has collapsed because of the recession, it is now down to 35% of GDP while Government spending is heading to 50%. This gap means that the cost of servicing the debt burden is overtaking other major areas of government spending like Defence and Education. The International Monetary Fund has issued its warning over the state of Britain’s public finances while the major credit agencies have followed suit. If any of these would downgrade Britain’s credit rating then the cost of servicing that debt will rise significantly. The next Chancellor of the Exchequer, whoever that is, will be in a very hot seat and will have to demonstrate his commitment to reducing public expenditure and raising taxes. It will not be enough to pass a law that the deficit will be cut in half as the Government is planning to do. It will have to show how it will be done.

It gives me no pleasure to write in this vein and a part of me thinks that expressing such views contributes to the doom and gloom because confidence is a key factor in the economy and so we should talk up the economy rather than talk it down. Indeed in the last major recession in the early 1990’s I wrote an article to that effect. I used to contribute a regular piece to Marketing Magazine when I was Managing Director of Sony Consumer Products UK. It was in the days before blogs, and in December 1992 in a Comment piece headlined “Time to talk up the economy”, I began “The other day in a meeting with a group of electrical retailers I was asked how long I thought the recession would continue. “As long as we keep talking about it,” I replied.”

However, I think the difference is that that recession was primarily driven by consumer confidence and the remedy was to get the consumer back on the high street. This recession is much more structural and the government’s response has put the long term recovery at risk. Consumers have actually responded quite rationally. Household debt has been reduced and the savings ratio is increasing for the first time in years. Personal debt and public debt were both too high. Now personal debt is coming down but public debt is soaring and is close to unaffordable. As I said the next Chancellor will be in a tough position but with few options. He will have to increase taxes but in time such measures will actually reduce GDP further and increase unemployment with its consequent increase in the welfare budget. He will try to reduce public expenditure, indeed he has to, but he must first have the political will to engage the public in honest debate or this will rapidly degenerate into an arm wrestling contest with the public sector unions. He must somehow generate growth in the economy to pay for all these bills. But at present the economy is retracting or at best stagnating. The definition of a recession is two consecutive quarters of negative growth. There are many problems with this but the first is that we persuade ourselves that it is over when we get a third quarter of growth. What has actually happened in the past two years is that we have had six consecutive quarters of negative growth, the longest run in the post war era. The Prime Minister told us at the beginning of this cycle that we were best placed to deal with this recession. But it turns out that among developed economies we were worst placed, except possibly for Ireland. The economy is now 5% smaller than it was two years ago, but remember the previous trend of growth was 2% per annum so it should have grown by more than 4% in the past two years and therefore we are nearly 10% below where we should be. It is ludicrous to suggest that if the fourth quarter of this year shows growth we are in recovery.

I fully expect that the fourth quarter will show growth but mainly because of a distortion that Alistair Darling introduced into the economy a year ago. He reduced the rate of VAT from 17.5% to 15%, itself a strange move, and promised that it would return to 17.5% on 1^st January 2010. and so it will. This means that many retailers will bring forward their sales to December to encourage consumers to avoid the increase in VAT. Businesses, particularly those running construction projects, will do everything they can to complete as much work as possible by 31st December. I am involved in two organisations that have major construction projects and that is exactly what we are doing. So December output will be artificially boosted. The January reports will say the fourth quarter grew and in January the media will report that we are out of recession, which technically we will be.  Then in January all this output will be lost. That will not be reported until April, when possibly the civil service will be in purdah for the election and perhaps the message that the economy is back in decline will be obscured.

There is another factor that should be considered. Throughout the last ten years until 2008 there has been steady growth in the economy. But there has also been steady growth in the population at a faster rate than in previous years. Growth per capita has been very limited if not non existent. Obviously the larger the population the greater the need for public services. If the economy is not growing then the proportion of total output taken by the state will grow until eventually the private sector cannot sustain the burden placed on it by the non-productive public sector.

I promised not to write a blog about politics (although I did not promise not to write about economics) so what is the message for business? Well the opportunity, indeed the overwhelming need, is to have a fundamental review of how public services are delivered. We need a revolution, not with blood in the streets, but in terms of how the economy is better managed with a greater contribution from the private sector. This should not be about consulting firms ripping off the government for over expensive under delivery. It should be about taking the discipline and the innovation of great competitive businesses that have to fight every day for their customers into the business of government. This in turn can lead to sustained economic growth.

Copyright David C Pearson 2009 All rights reserved