London's long boom is at an end, but somebody needs to tell the Mayor

The congestion charge will strike an economy already on the way down, and it will reinforce the cyclical downturn

The London economy is in trouble – and that has serious implications for the rest of the country too. For the past 15 years the London economy has been the great locomotive of British prosperity. Just as the UK economy as a whole has out-performed most of continental Europe, so London has out-performed the rest of the UK. It has been an extraordinary run, which over the past eight years in particular has seen growth of between 3 and 6 per cent a year. This has led to London's GDP being larger than that of Switzerland, Belgium, Sweden or Russia. More remarkably, GDP per head is now higher than that of any country, bar the special cases of Luxembourg and the United States.

The London economy is in trouble – and that has serious implications for the rest of the country too. For the past 15 years the London economy has been the great locomotive of British prosperity. Just as the UK economy as a whole has out-performed most of continental Europe, so London has out-performed the rest of the UK. It has been an extraordinary run, which over the past eight years in particular has seen growth of between 3 and 6 per cent a year. This has led to London's GDP being larger than that of Switzerland, Belgium, Sweden or Russia. More remarkably, GDP per head is now higher than that of any country, bar the special cases of Luxembourg and the United States.

You could see this growth in many ways, including the increase in congestion and the surge in house prices. London has been adding up to 100,000 people to its population each year and it would have been astounding had this not shown up in pressure on the infrastructure. But now something has changed. Pressure on the infrastructure has not evidently eased much, for special reasons of which more in a moment. But other measures suggest that London is somewhere between stagnation and actual recession.

Estimates from the Centre for Economics and Business Research suggest that the London economy has been shrinking since the middle of this year. The centre expects only 0.7 per cent growth in 2003. Those are just estimates of course, but they tally with the employment figures, which are falling and may fall faster next year when London gets council tax increases and the congestion charge.

They would also tally with what has been happening, or rather not happening, in the housing market. The top and upper ends have come to a halt. Prices have not yet fallen much because people are loath to acknowledge that their property is not worth what they thought it was, so the statistics are not yet catching up with what has happened. In any case the lower parts of the market are still moving. But as always happens in the early stages of a property slump, the top end starts a ripple that works its way down. Then prices at all levels start to fall as distress sellers emerge.

So what has gone wrong? The core of the problem is that three of the big driving forces of the economy have been particularly hard hit by the global downturn: finance, communications and tourism. The financial services story is well known. Employment does not seem to have fallen by very much but earnings have. Because the industry is so volatile a huge proportion of pay is in the form of bonuses, which last year were down sharply and which this year will be worse. This is one of the main reasons why the Chancellor is in trouble with tax revenue. Income tax receipts are stagnant despite the rise in overall wages. This is because nearly a quarter of income tax is paid by the top 1 per cent of earners, many of whom work in the City. Even if markets recover next year, there will be delay before this comes through in City pay packets. So expect another year or two of stagnation in that industry.

Communications have been similarly hit by the collapse of advertisement revenues, telecommunications charges and installation of communications equipment. To take one example: more international phone calls are made from London than any other place on earth, which means that as rates fall so does revenue. To take another: only three of the 13 internet route servers are outside the US, one in London, the others in Sweden and Japan. Being a communications hub is great in times of boom, less great during a slowdown.

Finally tourism has also been disproportionately hit. British tourism was already in trouble from foot and mouth, and London suffered because it is the prime entry point for all tourists to the UK. Tourism is important not only for its size (some 8 per cent of London's GDP) but also as an employer of lower-waged people. London needs an industry like tourism to balance the high-wage jobs elsewhere.

You can, incidentally, see the loss of low-waged jobs with the disappearance of hand car-wash sites and the lower staffing of those that remain. Like taxis and restaurants, these are a sensitive indicator of the state of the economy – the first things people cut when they are feeling less flush. I suspect that if you took account of the decline in the cash economy there would be evidence that London was taking an even larger hit than the official figures show.

So why has the slowdown not shown through in less congestion? To some extent it has, for car journeys in central London are down 17 per cent. It does not feel less congested, partly because of the schemes introduced to slow the traffic and partly because of the failure to agree a financial mechanism to improve the Tube.

The disturbing question is whether the congestion charge to be introduced next spring will further damage the London economy, particularly the central London economy, by increasing the costs of running businesses and by siphoning off money that would otherwise be spent in shops, bars and restaurants. (If congestion in outer London is increased, that may damage the economy there too.)

We don't know what the effect will be, because there has never been a similar experiment carried out in a city of anything like London's size. But it is pretty clear that this is a bad time to be introducing an additional tax. It will strike an economy that is already on the way down, and it will reinforce the cyclical downturn.

That leads to a further and even more disturbing question: is the problem just cyclical or are there structural weaknesses too? Lags in economics are pretty long. London's boom was mostly fortuitous, a function of having critical mass during a period when that seemed to matter, coupled with the out-performance of English-speaking economies in general. But the success story really started when the old Greater London Council was abolished and the boroughs began to compete against each other more effectively. Well-run boroughs set standards that others had to try to emulate. Not all succeeded but the general standard of management rose.

Now that process has to some extent moved into reverse. It is partly a coincidence but it does seem the end of the boom has coincided with the introduction of a mayor. I am not sure that the present incumbent quite realises how nimble policy needs to be in the face of changing economic factors. Most people instinctively feel that London needs some sort of central body to oversee it. Actually it works much better when decisions are decentralised: when the different parts compete against each other as happened during the 15-year boom. It sounds odd to people brought up to believe that planning is a virtue, but economic conditions change so fast now that it is much better to respond quickly to market signals, particularly if you're planning for a boom that is clearly past.