Bill Jamieson: Weighed down by our own debt

YEAR two of roaring recovery, and if all you can hear is the tapping of a blind man's stick, it's the Chancellor approaching with words of reassurance.

Let's suppose, as many looking at our dismal economic performance have already done, that George Osborne's "Plan A" for recovery and deficit reduction isn't working. Let's suppose, as a fair number have also done, that "Plan B" - greater public spending or tax cuts through higher borrowing - runs risks with our credit rating and won't work either.

Now let's suppose, as a growing number are doing, that both plans are inadequate for the task; that the public has not yet grasped the magnitude of the debt mess we are in and that we may now be past a point of no return, unable to grow our way out of the debt hole.

David Cameron, reported to be frustrated by the state of immobility to which his Chancellor has led us, has taken to concerning himself with the nation's happiness. Who can blame him, given the depth of the problems we face and that it could take a further five years before output returns to its pre-financial crisis level? Many businesses have struggled over the past two years just to survive. The prospect of another five years in the Fingernail Club, and with a rising failure rate, is appalling. Yet that is the prospect which senior officials in the Bank of England and the Treasury have come to accept as the more likely.

Might the truth be that, as a chilling assessment published this week concludes, the UK is now caught in a high-debt, low-growth trap - one from which no conventional Plans A, B or C will deliver us? "Britain's flat-lining, debt-addicted, post-bubble economy", writes economist Dr Tim Morgan, "cannot generate sufficient growth to sustain levels of debt which are far higher than generally realised."

His unsparing analysis for broker Tullett Prebon of the debt black hole we are in is one of the most informed analyses I have read of our situation and deserves particular attention in the wake of dismal GDP numbers and a markedly weaker CBI Industrial Trends survey yesterday.

Consider what it has already taken just to achieve growth barely better than standstill: ultra low "emergency" levels of interest rates, now persisting for well over two years; fiscal stimulus since 2008 totalling 250 billion through extra borrowing; 200bn of monetary easing by the Bank of England through Quantitative Easing; "Project Merlin" targets to boost bank lending to business; and a continuing devaluation of sterling.

This mash-mash of Plan A, Plan B and the tapping white stick has delivered growth of just 0.7 per cent in the year to June and the prospect of growth struggling to hit 1 per cent this year - far, far short of the 1.7 per cent forecast made by the Office for Budget Responsibility back in March.

And this matters, because no less than 84bn, or just over half of the coalition's deficit reduction plan, is to be achieved through higher tax revenues flowing from those OBR growth projections. But the likelihood of these forecasts being met is disappearing like some shimmering mirage over the horizon.

The key arguments in this analysis are these: first, Britain is in a far bigger debt mess than the public realises. Second, more than half the economy is unable to grow because of debt saturation and spending constraints. Third, conventional alternative measures are more likely to compound the problem than resolve it. And fourth, the scale of reform required is unacceptable to public opinion.

Official debt numbers (currently 900bn, or 60 per cent of GDP) do not convey anything like the whole picture. Unfunded public sector pension commitments and obligations under PFI contracts add 1.35 trillion, taking the debt figure to 2.5 trillion or 167 per cent of GDP. The potential costs of financial sector intervention add a further 1.3 trillion. The grand total comes to 135,000 of public debt for every household. Now add private debts such as mortgages and consumer credit, and the total rises to 5 trillion, or 340 per cent of GDP.

Now, all economies function with a fair measure of debt. And even the extreme levels we have now are just about manageable, provided that strong economic growth generates the revenues - public and private - to meet the payments of debt interest and principal.

But the problem with this is that much of the economy is now incapable of growing because the debt burden has grown so huge. The commanding heights of the UK economy, Morgan argues, are almost entirely dependent upon private borrowing and public spending (the latter also of course debt-dependent).

Three of the eight largest sectors - commercial and residential property, construction and financial services - which enjoyed bubble-like growth in the years leading up to the crisis account for 39 per cent of economic output. Another three, accounting for 19 per cent, are health, education, and public administration and defence. For these, the growth rates experienced over the last decade are truly over. All told, these sectors account for 58 per cent of the economy and are poised to shrink, not grow.

To this list, the retail sector may now be added, given the store closures and bankruptcies in recent months. "All told", Dr Morgan writes, "the UK is in an 'ex-growth lockdown', with as much as 70 per cent of the economy incapable of growth and very probably poised to shrink." If that seems overly gloomy, you only have to look at recent business data - Scotland or UK-wide - to see how uncomfortably true it is.

What is to be done? The conventional response is to boost government spending and reduce tax, preferably on lower-income households - the Keynesian version of the blind man's stick, only with rubber tips to muffle the tapping. The Scottish Government has called for more infrastructure projects - not unreasonable, providing it can release resources from elsewhere in its 30bn-plus budget. The problem is that it takes considerable time, particularly with Scotland's planning regime, before such projects are "shovel ready".

Among Dr Morgan's recommendations are a switch in the payment of welfare benefits from cash to benefits in kind, and the lifting of small firms out of most employment regulation if jobs are to be created. The alternative - if such it be called - is to keep tapping the stick and hope we avoid the precipice.

• Thinking the Unthinkable: Might there be no way out for Britain? by Dr Tim Morgan is available through www.tullettprebon.com