Jeremy Warner: Sorrell worries about fiscal threat to upturn

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Outlook It's not this year that Sir Martin Sorrell, chief executive of the advertising giant WPP, worries about, or next. Rather it's what comes after when governments around the world are confronted by the brutal reality of what to do about the burgeoning fiscal deficits they are acquiring in trying to manage their way through the recession. Do they don the hair-shirt and attack the deficit in true Thatcherite style, or do they simply ignore it and hope that inflation eventually does the trick for them?

If it's the former, then even the anaemic growth that Sir Martin anticipates for 2010 will fast seep away, and if it is the later, then we may well be in for a prolonged period of 1970s-style stagflation. Either way, it is not a happy outlook. In the meantime, things could scarcely look grimmer. A while back, WPP said it was budgeting for a 2 per cent drop in like-for-like revenues this year. That target plainly looks too optimistic after the 5.8 per cent fall reported yesterday for the first quarter.

Sir Martin says he senses a more confident mood returning to markets, especially in the emerging economies of Asia and Latin America, but thinks it will take time before this translates into discernible economic recovery. For the time being, the mix shows little sign of changing. Digital is gaining at the expense of traditional media, while geographically, emerging markets are performing much better than depressed western Europe and the United States.

WPP has cleverly managed to position itself to take advantage of both phenomena. Unfortunately, it is still largely the advanced economies and the mature players of traditional media that pay the bills. WPP cannot rely on Asia, Latin America and the shift to digital to sustain growth.

With governments desperately looking for new sources of tax revenue to fund their deficits, WPP's decision to shift tax domicile to Ireland looks smart – until you realise that Ireland has an even bigger fiscal problem than Britain. Ireland has pledged not to raise its low levels of corporate taxation, but for how much longer can that promise be kept? There may be nowhere left to hide.

Sir Martin goes to the heart of the problem in wondering where the future growth is going to come from. Governments have sought to compensate for the deleverage that is going on in banking, business and among households by borrowing and spending much more themselves. This doesn't provide any kind of a long-term solution, but merely replaces one credit overhang with another. The necessary workout is being transferred from private to public sector, but the eventual pain will be no less severe.

What makes the coming fiscal consolidation even more daunting is that many of these deficits are as much structural as cyclical, particularly those of the US and Britain. They didn't just start with the recession. The resulting fiscal contraction is therefore going to be that much more painful. Unless of course the politicians determine simply to inflate it all away. As Britain's long postwar history of inflation demonstrates, economically that can be just as painful.