21/07/2011 19:11 BST | Updated 20/09/2011 06:12 BST

It's the Economy

David Cameron must be thinking that the hacking scandal is the worst thing to happen to his Premiership. He certainly still has some big questions to answer, as Ed has been pressing. But the Prime Minister may come to think that hacking is a welcome relief from answering questions about the economy - which in the last two to three weeks has produced figures showing all the vitality of a fatigued and ageing tortoise.

Call it basic but just look at the components of growth. Private consumption is depressed, not just by a few days off with the Royal Wedding, but by the substance of declining real wages and extra saving (the latter is one reason that it is foolish to argue that first quarter low growth cannot be blamed on Government policy, on the grounds that the squeeze hadn't really started; the truth is that the Government went out of its way last year to frighten the living daylights out of people, and succeeded, with the result that spending is depressed). Private sector investment is held back not by weak balance sheets - as I understand it corporate balance sheets are much stronger - but by the fact that there is little anticipation of demand, and there are bigger returns elsewhere, so big British corporates are investing elsewhere in the world. Meanwhile Government spending is being squeezed. And the trade balance has suddenly gone in the wrong direction according to the last figures. Throw in the inflationary problem and you have a mad cocktail.

The result is increasing concern about the next set of UK growth figures for the second quarter, and alarm about the future. Monday's Daily Telegraph said that the Government needed a growth strategy. The Times has been lamenting the lack of one for some time. It is a pity that these papers were cheering on deficit zealotry last summer. Nick Clegg's argument on Sunday on the Marr show - that Greece's problems show why the Government is right to eliminate the structural deficit in four years - is precisely wrong. Greece's problems show the danger of an austerity (plus European bailout) plan that has no growth plan. As I pointed out when the Tories first raised the Greek spectre in the General Election campaign, Britain has much longer maturity on its debts, much higher levels of domestic cover for borrowing, and much lower debt than Greece. Our danger is Japan style low growth for a decade, not the Greek problem.

The danger for Britain is set out in exemplary fashion in a brilliant testimony from June 2010 to the US Congress by Professor Richard C Koo of the Nomura Research Institute in Tokyo. He coins the idea of a "balance sheet recession" where the private sector - household and corporate - sets out to minimise its debts. He wrote: "Today, the US, UK, Spain, Portugal and Italy (but not Greece) are in serious balance sheet recessions with massive private sector deleveraging even with near zero interest rates... In all the above countries, increases in private sector savings during the last two years have exceeded increases in government borrowings, which suggest that governments are not doing enough. Yet policy makers spooked by what happened to Greece have made strong pushes to cut budget deficits as quickly as possible...only looking at increases in the [public] deficit while ignoring an even bigger increase in private sector savings. Removing government support in the midst of private sector deleveraging will repeat the Japanese mistake of premature fiscal consolidation in 1997 and 2001 which in both cases triggered a deflationary spiral and increased the deficit. The US made the same mistake of premature fiscal consolidation in 1937, with equally devastating results."

The problems in Europe are increasing and real. I said in Poland two months ago that the options were all the more costly than the previous year. They are worse now. And the insistence that there is no hurry to solve them only makes things worse still. A comprehensive resolution should address debts too big ever to be sorted out, bank balance sheets that are too weak, and the need for European shared endeavour that recognises Germany gets an undervalued exchange rate in return for taking the strain through, for example, Eurobonds and a growth strategy. The Tory argument that Britain would lead the way through exports was just talk. Government spending is not just about paying people to dig holes and fill them. It needs to recognise the scale of the productivity challenge and the role of public investment as a multiplier of and catalyst for private endeavour.

So as we head for summer, I think we need to look at whether under performance on growth is not just threatening living standards, but also threatening the fiscal targets that the government set last year. The very real possibility of missing the OBR growth forecasts by just an average 0.4% per year will make the target of any reduction in debt levels to GDP by the end of this Parliament impossible.

This is NOT deficit denial. It is a hard headed judgment about how fast you can reduce the deficit without killing off growth. The Government's logic - that deficit reduction itself is the spur to growth - is very odd. It is essentially saying that the way to expand the economy is to contract a big (government) part of it. As Larry Summers wrote, that is just perverse when there is no evidence of government spending crowding out private spending - "the notion of an expansionary fiscal contraction is every bit as oxymoronic as it sounds". Whatever the problems of government policy before the recession, the plan afterwards to halve the deficit in four years but continue to nurture and support private sector confidence with government contribution to growth was right and is needed today.

The Government may feel that the costs of retreat from Plan A are too great; but the costs of sticking to it could be greater.

This blog can also be read on David's website