Outlook: Stock market halves; employment growing. Is this for real?

The bear market passed another milestone yesterday as the FTSE 100 slipped quietly past the point at which it is more than 50 per cent off its turn of the century peak. With even the real economy now self-evidently in a state of some difficulty, the Chancellor can to some extent continue to blame the uncertainty of war against Iraq and cite the fact that some European bourses have fared even worse. Even the S&P 500 is 47 per cent off its peak, and if you take the totality of American stock markets, including the Nasdaq hi-tech exchange, then US shares have probably lost more than half their value too.

None the less, the excuses are wearing thin. Gordon Brown has long stressed that the UK economy cannot remain immune for ever from the economic strain apparent in the rest of the world, but he has also been quick to boast of the UK's superior economic performance whenever occasion permits. We are little more than two months into the year, but already the forecast made only four months ago of 2.5 to 3 per cent growth this year and 3 to 3.5 per cent next looks hugely optimistic. People have challenged the Chancellor's forecasts with similar language before and always he's been eventually proved correct. Even Mr Brown must realise that this time he won't be.

The calculation he must make in next month's Budget is whether it is worse to be accused of being unrealistic with his forecasts or to slash them and thereby confirm that the Government too thinks the economy is sliding towards recession. Whatever he decides, it is plain his problem with the public finances has grown infinitely worse over the last two months. The Chancellor desperately needs the extra £8bn of national insurance he's pencilled in, but higher NI contributions might be all that's required to tip the economy over the edge into recession, and if that happens then planned increases in public spending must be in serious jeopardy.

It is sometimes claimed that war against Iraq is all about oil. Whatever your views on the rights and wrongs of this conflict, no sensible analysis of the present stand-off could lead you to that opinion. Mssrs Bush and Blair are taking huge risks not just with public opinion by pursuing this conflict, but also with their own economies. Oil prices yesterday rose to their highest level since the last Gulf war, further depressing already fragile business confidence.

The possibility of a double dip US recession, so much discussed a year ago but then largely dismissed as unduly alarmist, seems now to be almost upon us, and if the war proves prolonged, it is an absolute certainty. Eventual success in Iraq might significantly and durably lower the oil price, but that is not going to be of much help to Bush and Blair at the ballot box if in the meantime geopolictical conflict has pushed their economies into recession. No, whatever else this war is about, it is not about oil, for its political and economic risks are too great to justify the prize.

Mr Brown has notably kept his counsel on war against Iraq as the Prime Minister "recklessly" risks his future on its pursuit, and maybe the war will finally give the Chancellor the shot at Number 10 he has so long craved. But it is not just the war, or the fallout from the Great Bubble, that are to blame for our fast deteriorating economic disposition. Rising taxes are a big part of the mischief too. OK, OK, so unemployment is at an historic low and living standards are still rising, and who can argue with that. The question is for how much longer?

On most measures, the UK stock market has begun to look undervalued, even though the overvalued US stock market could still push it lower. I'm even backing my judgement by resuming my AVCs. With nearly a half of the FTSE 100 yielding more than 5 per cent, London equities once more seem a reasonable bet. I'm not sure the same can be said for the short-term economic outlook. Is it really possible for share prices to halve and for there to be virtually no impact on living standards and general economic well being? I don't think so, and I fear that for many the real economic pain may be only just beginning.

Higgs/Buffett

According to the CBI, eight out of ten FTSE100 chairmen disapprove of key elements of the Derek Higgs report on boardroom reform, a finding you might not find all that surprising given that the position of chairman would be diluted if Mr Higgs gets his way. Even so, eight out of ten is a big groundswell of opposition from the existing ranks of the British boardroom, and the Government would be ill advised entirely to ignore it.

I've all along seen Higgs as a relatively harmless set of reforms that might have some beneficial effects, and nothing any chief executive or chairman has said to me, some of it frankly patronising in its defence of the status quo against its critics, has led me to change that view. Warren Buffett's annual letter to shareholders in Berkshire Hathaway, which contains a largish section on corporate governance, therefore holds more than usual interest.

Mr Buffett, the investment guru sometimes referred to as the Sage of Omaha, is mainly concerned with the US corporate scene, which is having to deal with the more oppressive stipulations of the Sarbanes-Oxley Act, but exactly the same points can be made about the Higgs recommendations. Mr Higgs will be relieved to learn that there is quite a bit of support in Mr Buffett's analysis for what the report is trying to achieve, as well as some implicit criticism.

Indeed, Mr Buffett makes the case for reform as well as any I've seen. Too many CEOs, he says, have in recent years behaved badly, drawing obscene pay for mediocre business achievements. In Mr Buffett's view, outside directors should behave "as if there was a single absentee owner, whose long-term interest they should try to further in all proper ways".

This means they must get rid of a manager who is mediocre or worse, no matter how likeable he may be. Independent directors fail in their charge not so much because of inadequate laws, but because in a boardroom populated by well-mannered people it is awkward if not impossible to raise the question of whether the chief executive should be replaced.

"These social difficulties argue for outside directors regularly meeting without the CEO – a reform that is being instituted and which I enthusiastically endorse." So far, so supportive of the basic raison d'etre of the Higgs reforms – that a system be found whereby it is the interests and judgement of the owners (the shareholders) that get pursued, rather than the chief executive and his thieving advisers.

But Mr Buffett wouldn't be the Sage of Omaha if he didn't give it with both barrels in equal measure to both two sides of the debate, and it doesn't take long for him to part company with all the paraphernalia of strictly correct corporate governance. "I doubt," he observes, "that most of the other new governance rules and recommendations will provide benefits commensurate with the monetary and other costs they impose." And just to rub home the point: "Certain major investing institutions have glass house problems in arguing for better governance elsewhere."

Mr Buffett plans to find his "independent" directors among his own shareholders. They will be people, he says, who either directly or through their families have had large shareholdings in Berkshire Hathaway for a long time. That way they will both know about the business and have a vested interest in seeing it prosper.

This is an idea only really possible in the US, where it is quite common for unconnected individuals to be substantial shareholders in big, publicly quoted companies. But it finds its parallel in the Higgs proposal that there be a senior independent director who is not the chairman to act as a conduit for the views of owners. The trouble with the CBI's full frontal attack on Higgs is that it looks too much like the last gasp of self-interested reactionaries. The CBI would be much more likely to persuade the Government of the fault lines in Higgs if it embraced the need for reform and, like Mr Buffett, offered some plausible alternatives.

jeremy.warner@independent.co.uk