Outlook: A downturn that's worse than anything since the mid-1970s

Attractions of the PPP Â

Remember Tony Dye, the Phillips & Drew Fund Management chief who eventually lost his job for being consistently bearish? These days he runs his own set-up, Dye Fund Management, and it might not surprise you to learn that having eventually been proved right, he hasn't much changed his views. Even with shares at their current, depressed levels, he's still bearish, and he thinks that as far as the wider economy is concerned, there could be much worse to come.

Mr Dye's mistake when he was at PDFM was that he identified the stock market as a bubble at far too early a stage in its development. Mr Dye must have turned bearish at about the same time as Alan Greenspan made his famous remarks about irrational exuberance, which was as far back as 1996. But unlike Mr Greenspan, who subsequently blew with the wind, Mr Dye stuck to the view and acted on it. As shares continued to rocket upwards, Mr Dye's clients became increasingly disillusioned. Well, the index is now back to not much more than it was then, and given that Mr Dye was a "value" investor, spurning the creations of the TMT revolution, those that stuck with is methods are probably now doing at least OK if not rather nicely.

Mr Dye doesn't like the idea of for ever being labelled a prophet of doom, but he was ultimately right about the bubble even if he was ahead of his time, and he still thinks that things will get worse before they get better. His biggest concern remains the US where many of the imbalances which originally led him to the view that stock markets were riding for a fall have if anything got worse over the last couple of years, not better. That's because the Fed has dealt with the aftermath of the bubble and 11 September by sharply cutting interest rates. The bubble in the stock market has in his view only migrated into the housing market, helping to keep consumer spending buoyant, but fuelling ever higher levels of household debt.

There are not many more rabbits that Mr Greenspan can pull out of the hat, and when the music stops, as eventually it must, then the economic correction may be severe. In the meantime, corporate earnings continue to suffer and there's little sign of the sustained upturn in business investment that would be necessary to counter any hiatus in consumer spending. OK, so there are lots of ifs and buts in this analysis, and in practice things are unlikely to turn out quite as dire as it suggests. But it's one of the reasons why all recent attempts at a stock market rally have ended in tears.

No one yet wholly buys the recovery story. The chances of a double dip remain high, and that's without even thinking about Iraq. Even the ever optimistic US Treasury Secretary, Paul O'Neill, conceded yesterday that the US economic recovery would not be "a rocket shot to the moon", which for him marks a considerable retreat from more upbeat statements. Indeed, the recovery would "obviously not be smooth, uniform and yogurt-like". We've had bath-shaped recoveries, saucers, corrugated iron, Ws, Vs and Us, but never before has anyone suggested it might be "yogurt-like". In any case, whatever a yogurt-like recovery is, we are apparently not about to have it. The best that Mr O'Neill predicts is that it will be "bumpy".

In the meantime, the stock market continues to look like a complete mess. The only shares investors seem willing to buy are the "defensives" where earnings look safe – tobaccos, food, supermarkets, and mortgage banks. Such sectors have become so fashionable that there is a real danger of a "defensive" bubble being created to replace the old "TMT" one. With the S&P 500 once more heading back towards the 800 mark, stock markets are again beginning to signal very difficult circumstances ahead. It is no longer possible to view the bear market of the past two and a half years as simply a valuation adjustment. It is much more serious than that. For the capital markets at least, this is the worst downturn since the mid-1970s and it may may not yet have run its course.

Attractions of the PPP

The trade unions are in confident and militant mood again these days, and it is easy to see why. After one of the longest periods of uninterrupted economic growth in history and with unemployment still incredibly low, it might be surprising if they weren't. With Labour now well into a second term, and with little prospect of being defeated any time soon, the unions reckon it's pay-back time. They want more money, better conditions, higher pensions, more holiday, shorter working hours and better healthcare.

Notwithstanding the very substantial increases in public spending already being pushed through, they also want an end to the public private partnership experiment. That, in any case, was one of the demands listed yesterday by Dave Prentis, general secretary of Unison, the public service union. The PPP, he said, was like "paying for a mortgage on your Barclaycard".

In some respects he's got a point. It's always more expensive for the private sector to borrow than the public sector, and in any case, when the private sector builds a hospital or a school, it wants a profit on top of the capital costs. In Mr Prentis's view "taxpayers' money is being wasted, pay and conditions are worse, and the state is being ripped off".

Well, that's one way of looking at the world, but it is also one which would lead to fewer schools, hospitals and jobs, and while Mr Prentis's members with their statutory employment rights and guaranteed final-salary pensions might not think that matters very much, the rest of us most certainly do.

There is only so much the Government can borrow to spend each year without mismanaging the economy, and it is already approaching that limit. And yet, as Mr Prentis would no doubt acknowledge, there is a huge backlog of underinvestment in health and education that needs to be addressed. There's lots of work to be done, but not enough money to do it. The Chancellor is seeking to bridge this funding gap by persuading someone else, the private sector, to do the work instead, and then paying them back over a period of time. An accounting fiddle? Not at all. It's just a way of spreading the capital costs of a project over a number of years, in the same way as we all do when we take out a mortgage to buy a house.

The other claimed benefits of the PPP are much more arguable. Is the private sector so much more efficient that it can pay the higher borrowing costs, make its rate of return, and still come in cheaper than the public sector? Sometimes, but not always. The consultants hired to confirm that the PPP for the London Tube was good value for money had to lean over backwards, perform a couple of somersaults and then disappear up their own derrière in order to make it look cheaper than the same work done in the public sector.

On the other hand, you only have to look at the tens of billions of pounds squandered in the post-war period on Britain's nuclear power programme, all for assets now valued by the stock market at virtually nothing, to see the full horror of what can go wrong when politicians decide to pay for their pet projects directly with taxpayers' money. No one is suggesting the PPP is a panacea, but it is surely better than not having the spending at all and it does have the effect of keeping the lid on the public sector's wilder flights of fancy. What a shame that Mr Prentis is incapable of seeing it.

jeremy.warner@independent.co.uk