Margareta Pagano: Osborne needs to mix magic with psychology – and a dash of anarchy

UK firms have £75bn locked away, but they're too spooked to spend it. So the Chancellor must give them the confidence to invest, or else ...

Lunch in London last week with Hugh Blackwood, one of the UK's top industrialists, sent shivers down my spine.

Not, you understand, because the food or the company wasn't good – both were delightful – but because the Scottish engineer's prognosis for the UK economy was so unbearably gloomy. And it was made all the gloomier because Blackwood knows exactly what is going on in the bowels of the economy – he runs the international arm of URS, a Fortune 500 US engineering giant, which also takes care of the nuclear waste at Sellafield.

Blackwood, who joined after URS gobbled up Scott Wilson – one of Britain's last independent engineers – now heads, among other projects, the cable car over the Thames for the Olympics, Crossrail and HS2 rail. So he has a more acute eye than most; he talks all the time to construction firms, contractors, project managers on the ground, as well as suppliers. And the message is not good; many are chopping workers by the hundreds, export orders and contracts are drying up fast in Europe and in the Far Eastern markets, and confidence is falling off a cliff.

This is terrible news because since the financial crash it's been our manufacturing and engineering firms which have been leading the charge, showing seven consecutive quarters of growth. But over the past few months, specifically since the deepening eurozone crisis over the summer, British industry is suffering, and is now in what Blackwood describes as the "under stress" stage.

Even top manufacturers with good export order books are coming under pressure because when firms are struggling in their domestic market, as they are in the UK, they then stop the investment in products and training which are necessary to keep production running; a painful and vicious circle. We know that companies have cash – about £75bn is the number for the cash locked away in the corporate balance sheet – but they are all terrified of spending it, even on the most basic of investments such as new photocopiers.

Secretly, I had hoped the charming Glaswegian was taking a dreich view, but after talking to Terry Scuoler, head of the Engineering Employers' Federation, it's clear that there's been a seismic shift in mood and orders. Scuoler says his members are reporting a cut-back in work as their order books are slashed in all their world markets. And just in the past few days, one south Wales firm supplying automotive components to Fiat in Italy has had orders cancelled, while Honda has cut contracts with a Yorkshire firm. And it's not just European countries suffering – Scuoler says EEF members report a slowdown from the Far East, too.

Blackwood and Scuoler are the sort of people that politicians such as the Chancellor, George Osborne, should have been listening to the most over the past few weeks as he put together the growth strategy for Tuesday's Autumn Statement. If he had, they would have told him this; that it's vital to spend as well as keep the deficit-reduction plan on track – a "Plan A-plus", in the jargon. They would also say he must give the green light to the £40bn or so of infrastructure projects already hinted at, including schemes to upgrade important roads such as the A14, rail and airport expansion, growing the National Grid, new nuclear plants, taking broadband to every inch of the country and making it free, and more investment in basic skills and training – there are many jobs which can't be filled because of skills shortages.

There is money available – some government departments have cut back so much they are beginning to store cash. And starting a few of these "shovel-ready" projects has a powerful multiplier effect because it has an immediate impact on the economy. Workers paid on a Friday spend cash in the pub that night, and the family can go shopping the next day. And, as Sir Philip Green warned last week, with his slightly disingenuous disclosure that 260 of his shops will close over the next few years, the public is spooked.

Put simply, the Chancellor's challenge is to de-spook us all when he stands up this week; the next election depends on it. Osborne has no choice but to announce some bold building projects, as well as real boosts to get the private sector alongside his plans of "credit-easing" for companies.

From what one hears, the most sensible will be the project-specific bonds which will encourage pension funds and insurance firms to finance new projects, but backed by the public sector, financed in such a way they don't hit our AAA rating. The priority, by far, will be the concoction he comes up with to persuade companies and entrepreneurs to feel good enough to want to invest; manufacturers, rightly, want concrete incentives such as capital allowances and reforms of R&D credit.

But the trickiest bit for Osborne will be whether he says the coalition has abandoned all chance of reducing the structural deficit in this parliament. If he is to claim that the reduction plan is broadly on track, he has to show some evidence, and this is where the OBR's forecast, this week, will be crucial to confidence. The outlook across the Continent is so grim that it can't be long before the bond markets, once done with France, will turn to the UK, and it's a false hope to take much from the fact that our cost of borrowing has fallen below that of Germany.

So as well as being a magician, Osborne needs to play the anarchist too by throwing in some left-field incentives; by this I mean more imaginative employment schemes for the young, and the odd tax cut. And he must play pyschologist; soothing the stress of British industry and de-spooking the public. It's a tall order, but one he can't afford not to fulfil. If he's in any doubt about how bleak it is on the ground, I suggest lunch tomorrow with Blackwood – he's on standby.

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