Hamish McRae: It will be a bumpy ride but, politics apart, we are headed for recovery

Economic view
Click to follow
The Independent Online

The economic outlook is easier to see than the political one. This works both nationally and internationally. We can see that there will have to be a second budget here this summer.

What we cannot see is whether there will be a third one in the autumn. We can see that there will be fiscal consolidation everywhere. What we cannot see is quite how this will be done. We can see that the global recovery should gather pace as the year develops. What we cannot see is whether political unrest will lead to defaults in Europe and thus undermine the recovery.

I think, in trying to understand what might happen in the economy in the coming months, that it is important to stand back from the negative reaction on financial markets on Friday. The conventional view of market behaviour is correct in the sense that markets dislike uncertainty. Businesses dislike uncertainty too. So the immediate reaction was for the markets to mark sterling and shares down and for several business leaders to voice regret at the outcome of the election.

But things settle. The risk premium on UK Ltd has risen somewhat, and the new government, whatever its final complexion, will have to accept that. If in the next few weeks the Government can set out an acceptable revised programme for getting the country's finances under control, then much of that fear will fade away.

From an economic perspective that is the key immediate issue. There is not much time. So what should we expect?

There has been a lot of comment about the scale of the cuts in spending and the increases in taxation being unprecedented. That is true in the sense that even on the pre-election plans of the three parties (which actually were broadly similar in aim, and only slightly different in timing) the squeeze was at the limits of UK experience. But viewed globally there are plenty of historical examples of fiscal squeezes on a similar scale – and not going back to the 1920s either. As you can see from the graph, in the 1990s, the most recent reasonably serious recession, three countries made huge strides in cutting their deficits.

Top of the list was Sweden, which faced a banking crisis as well as an economic one. Public spending peaked at 67 per cent of GDP and even the Swedes were not prepared to pay taxes at that level. So during the 1990s, the country managed to get this ratio down to around 52 per cent of GDP, a fall of 15 per cent of GDP. Apply that decline to the UK and we would get our ratio down from its present level of 48 per cent of GDP to around 35 per cent of GDP, the level it was in 2000.

Or take Canada. There the decline was from 50 per cent of GDP to around 37 per cent, a very similar sort of consolidation that the UK seems likely to have to carry out over the next seven or eight years.

Most surprising of all, there is the case of Italy, so often held out as an example of weak fiscal management. It too managed to make a similar sort of cut, with spending coming down from 56 per cent of GDP to around 45 per cent.

Finally, don't forget what happened here. As you can see, UK public spending came down nearly 10 percentage points from its peak. So it has been done before. Indeed fiscal consolidation was quite common during the 1990s cycle. However, the main example of a contrary movement was Japan, and it is this experience that is troubling, as it was the first major country to run into fiscal difficulties and currently has a national debt of roughly 190 per cent of GDP. It will be virtually impossible for Japan ever to repay that debt, and, were interest rates to rise to global levels, even to service it. The country is able to continue only because it has huge domestic savings and its savers are prepared to allocate their savings to help fund the government. The social glue that holds the country together, something that a lot of outsiders understandably admire, enables the country to run fiscal deficits that would not be sustainable in a fully open marketplace.

That leads to what is happening in the very open marketplace of European sovereign debt – open because between 40 per cent and 80 per cent of eurozone countries' debt is held abroad, mostly in other eurozone countries but abroad none the less. So the social glue of Europe is being tested and it is self-evident that this is not as strong as the glue within Japan.

My own judgement is that Greece will default on its debts, not necessarily now, but within the next few years. Long before that this happens, the strains will show through in other ways. We have great political uncertainty in the UK. Much of continental Europe has great financial uncertainty, in some regards even greater than we face.

So what will happen?

First, there will be an initial austerity budget in the summer. If that is accepted by the markets, then there will be a few months of calm, but I am not at all sure that calm will last. If it is not accepted by the markets, then the summer and autumn will be very difficult indeed and we will, I expect, have to have another shot at it in the autumn. My own view is that it would be much safer to get an endorsement of our policies by the International Monetary Fund this summer, because having to have two bites at this bitter cherry will test our political system even more stringently than the one emergency budget will.

A year from now a proper austerity programme will be in place. There is no alternative. That programme will aim to get the deficit down to 3 per cent of GDP by 2014/15, with projected surpluses thereafter. No element of public spending will be ring-fenced. Several taxes, not just VAT, will have to rise. And the whole experience will not be a bundle of fun for anyone, including the government that has to bring it in. All that is obvious. We can see where we are going. What is not at all obvious is how we get to there from here. But that is politics.

And beyond 2011? Look, the global recovery will continue and we will share in it. It will be bumpy and there may well be another couple of quarters when the economy fails to grow, maybe even shrinks a little. As the effect of quantitative easing fades away, there will be reverses in house prices. But the get-out-jail card of a weak pound is already starting to pull up export demand and it is reasonable to expect the private sector to take up some of the slack as the public sector is forced to retreat.

The political problem will be that the growth won't feel like growth because so much of the additional resources that are being generated will, one way or another, have to go into servicing and then paying off debt. But we all knew that didn't we? As I said at the beginning, the economics are easier to see than the politics.

Crisis management needs to consider both brand and reputation

What is the difference between reputation and brand? The two are often used synonymously, though of course a brand is a narrower concept. Companies have reputations, their products are (or can be) brands. But three headline cases – where things have gone wrong – in the past few days have made me ponder how the distinction may be changing and how the two overlap.

Start with BP. It is clearly both a reputation and a brand. Protecting the corporate reputation from the adverse effects of the oil spill has been hugely important, as you can see from the way it has sought to present itself to the public and the US administration. The company has sought to do the right thing but some damage to the corporate reputation is inevitable. That will make life more difficult for the company in its relations around the world. But will the brand be damaged too? That will only be answered in some months' time and the issue will be whether product sales are hit.

Now consider Goldman Sachs. I don't want to go into the details of what it did or did not do, but the damage to its reputation will be huge. But since it sells its services to wholesale, rather than retail buyers, the damage to the brand matters little. Maybe the brand was not worth much; the value was in reputation.

Exhibit number three is Prudential plc. Wonderful name and a brand that will resonate with anyone who recalls its classic strip cartoon ads for pensions, where a gradually-ageing office worker becomes worried about not having made provision for his retirement. But the company has managed to damage its reputation for competence by mishandling the $35.5bn (£23.4bn) takeover of AIG's Asian business. So there has been huge reputational damage. But has the brand also been damaged? My instinct is not, or at least not very much.

Conclusion? The distinction is more subtle than just wholesale and retail, or corporation and product. But wise companies should consider both when coping with disasters, dealing with clients, or planning ambitious expansion.