Nasty not nice, but there may yet be a silver lining

Published on Friday 27 June 2008 21:56

MY COLLEAGUES at Deutsche Bank are profoundly pessimistic about the outlook for the UK. In fact, so much so that they asked me to make a presentation on the topic at the most recent quarterly meeting of the bank's global investment committee.

I told them that, after the shame of the 1970s and the pain of the 1980s, we reaped the benefits in the 1990s – what Mervyn King accurately (if inelegantly) refers to as the "nice decade" (non inflationary, consistently expansionary).

As decades go, the 1990s certainly was "nice". Economic growth was remarkably steady at around 2.75 per cent a year, while the retail prices index (RPI) rumbled around under 4 per cent a year until a spot of bother in early 2007.

So if you believe the propaganda, everything in the garden is rosy. With the longest period of sustained growth since the 19th century, the lowest inflation since the 1950s and the lowest unemployment level in Europe, what can go wrong? After all, we have a record of "prudent fiscal policy" and we are assured that the UK "economy is well placed to weather the global economic setback".

The truth, of course, is different. To call fiscal policy "prudent" is to strain credulity beyond breaking point. Government debt now exceeds the magic 40 per cent of GDP. OK, you don't (yet) see this in the official data but if you believe them I'd suggest a spell in the clinic. If the government accounted as do public companies (i.e. honestly) we'd likely find the debt ratio twice as big.

In short, after a decade of strong economic growth, the Treasury has lost the plot, the housing market's in a mess, consumers are exhausted and the economy has been driven so hard that it needs a cold bath to calm itself down.

In which case it's worrying that the Treasury shows no signs of rediscovering the plot. In fact, its recent behaviour makes you wonder if it's smoking something illegal. It's obviously in denial over public finances and has a growing habit of dreaming up radical tax measures on the back of a fag packet. Inevitably the result is that UK tax policy has become oppressive, retrospective, capricious and sometimes even vindictive. No surprise that "non-doms" – and companies – are considering better offers elsewhere. For those of us stuck here that's seriously bad news.

So the near-term outlook is pretty bleak. After-tax incomes have been under pressure for years but are now really squeezed. The adjustment in the housing market is turning out nastier than hoped, though this will in the end have been good for us. The government's spending spree is coming to an enforced end, except when there are by-elections to buy. Companies are in good shape but have no need to invest. So economic growth is falling abruptly and will stay depressed for the next nine to 12 months.

I do expect inflation to calm down as energy and food prices stop exploding, and this will pave the way for restorative interest rate cuts in 2009. By 2010 we shall see gradual recovery. This is by no means an unusual picture; most developed economies face a similar outlook. But the UK is distinguished from its peers by its unique burden – the economic consequences of Gordon Brown, of a decade of "gold plating" EC directives, of a litany of stupid policy decisions founded in breathtaking economic illiteracy.

This is pretty depressing stuff until you pause a moment and sniff the political wind. While across Europe and in the USA the drift seems to be away from hard economic efficiency towards something rather softer, here in the UK I sense an opposite drift, away from the "big state" and towards the notion of giving up less of one's earnings in tax for idiots to waste. If clouds do have silver linings, it could be that our current travails pave the way for a programme of gradual repair to our damaged economic structure.

And the moral? For my colleagues it was apparently a surprise that a Brit would trump their pessimism. For me it is confirmation that, on a medium-term view, diversification away from the UK still makes sense but – with a bit of luck and a fair wind – maybe not forever.

• Peter Bickley is director of economics at Tilney Private Wealth Management