Brutal for Britain - FT.com On the outskirts of Greater Manchester in England's north-west, close to the centre of long-struggling Salford, austerity Britain is on display in the Kandy Kabin convenience store. Sharon Smyth, co-proprietor, says business is harder than it has been in her 22 years behind the counter. We had someone in yesterday. He said they'd laid off 20 people where he works and he was just glad to have a job," she says. People are scared. If they have got money they are not spending it, because they don't know what is coming. The Salford sentiment Ms Smyth conveys is representative of the troubled mood across Britain, Europe's leading economy outside the eurozone and the world's sixth or seventh largest. Emblematic of the shift in global opinion against running large budget deficits that followed the financial crisis, Britain led the way in voluntary deficit reduction. But it is now enduring a prolonged period of near-stagnation and arguing about the cause of its difficulties. The eurozone's leading trading partner - also a big importer of goods from the US, China and Japan - is suffering and it is far from sure the medicine is working. Growth is expected to remain below 1 per cent in 2012 for the second year running and prospects have dimmed to such an extent that the Conservative-Liberal Democrat coalition government is now planning for seven years of public spending cuts and tax increases to rein in the budget deficit, rather than the five it had intended on coming to office in May 2010. With output still 3.6 per cent below its 2008 peak and little sign of a rapid bounceback on the horizon, Britain is having to get used to a prolonged period of adjustment after 25 successful years. "The economy had become very unbalanced," George Osborne, chancellor of the exchequer, told the Financial Times last week on a visit to Manchester. Unbalanced in that there were not enough exports, unbalanced in that we were too dependent on the success of financial services, unbalanced between the public part of the economy and the private part of the economy, with public expenditure taking almost half of national income. Contrary to his heady early days in the Treasury, a new realism now infuses the Tory chancellor's words. "Changing that is not something that is going to happen overnight and it has been made more difficult by the eurozone crisis," he says. But Salford is not simply an example of decline in a difficult part of Britain's former manufacturing heartland dominated by a much diminished textile industry. It is also witness to the adjustment Mr Osborne so fervently desires. A kilometre down the Langworthy Road in Salford Quays, the site of Manchester's former docks, regeneration is proceeding apace with the arrival of MediaCityUK, a £1bn ($1.5bn) site creating a hub of well-paid professionals in an attempt to regenerate redundant land and close the economic gap between north and south. Triple A status: Pressure in prospect for the UK's prized rating As Britain's prime minister and chancellor of the exchequer for the past 20 months, David Cameron and George Osborne have made regular boasts about the success of the UK in holding on to its top-notch triple A credit status. But now that rating agencies have started to carry through their expected downgrades of triple A rated countries in the eurozone, will the UK be next in the line of fire? French ministers and Christian Noyer, French central bank governor, have complained that in light of London's bigger deficit, higher public debt and inflation and weaker growth, the UK does not deserve to retain its triple A status any more than Paris. Rating agencies have also begun to warn that the UK is not as safe as it once was. Moody's, normally the most supportive, said in December that the UK's deteriorating finances and growth outlook had substantially reduced its ability to maintain the rating. "The UK economy is expected to have hardly grown in the two years between the introduction of the austerity measures and the middle of 2012," says John Wraith at Bank of America Merrill Lynch Global Research. If growth remains elusive, that will mean a bigger deficit and debt level than forecast, which could ultimately put renewed pressure on the UK's triple A rating. Despite the complaints in Paris and some concerns that weak growth could make it harder to pay back public debt, Britain does have advantages over countries such as France. For a start, it has a central bank that has shown it is willing to throw everything at the economy to revive growth. The Bank of England has launched two rounds of quantitative easing - buying government bonds to stimulate the economy - and is widely expected to launch another in February. The UK government has also been quicker out of the starting blocks in its attempt to rein in public debt, launching a fiscal austerity programme shortly after it was elected in May 2010. And being outside the eurozone, Britain does not face the worry of rising bail-out costs should Italy or Spain need emergency funding. But if the eurozone crisis is resolved, investors may switch out of gilts, putting upward pressure on yields. Alternatively, a deepening of the single currency's problems could hit the UK recovery. Either way, Mr Cameron and Mr Osborne may have to face the unpalatable prospect of Britain losing its triple A rating. In Booths, Salford's newest supermarket, the shelves are not stacked with the sliced white loaves and tinned food that dominate Kandy Kabin. Instead, stuffed quail at £5.99 and frozen beef bourguignon for £8.35 are offered to attract the 2,000 staff from the BBC, who have been relocated there from London and central Manchester. The regeneration not only involves a publicly funded corporation but is an initiative of the previous Labour government planned well before the recession. Relieved nonetheless at this rare local success story, Mr Osborne declares himself "thrilled" with the move. The arrival of the BBC at Salford is a huge opportunity to build up in Manchester a media hub with private companies servicing the BBC and Granada [now ITV]. People remember Manchester 30 years ago with the strength of Granada as the second media centre of the country alongside London and I think now Manchester is again the second media centre of the country alongside London. But Salford's rebirth - showing up in unusually rapid house price growth on the quays - is not reflected in many other parts of Britain. There, Kandy Kabin rather than Booths is the better reflection of the economy. A core problem has been deficient growth, which has persistently fallen short of expectations and kept unemployment well above the levels of most of the 1990s and 2000s. The Bank of England, for example, has revised down its expectations of the future level of UK gross domestic product 16 times running in each of its quarterly forecasts over the past four years. The central bank announced a resumption of money-printing, creating £75bn since October in a second quantitative easing operation and pumping it into the economy via the purchase of government bonds. The Bank now plans to have bought £275bn by the start of February. With demand showing few signs of revival, economists and financial market participants expect the programme then to be extended to at least £325bn. With the Bank unable to generate growth easily, the political storm over the economic outlook has intensified. Labour politicians blame the coalition government's austerity programme, the £42bn spending cuts and tax increases that have been implemented so far, which they say have gone "too far and too fast." The government insists that had it not announced further firm measures in 2010 and subsequently, the country would have lost the confidence of the bond markets and things would be even worse. Most economists see the fierce political arguments as of little relevance to the question of why the economy has disappointed expectations so greatly. The Office for Budget Responsibility, the independent body charged with advising on the public finances, explains its forecast downgrades not with reference to spending cuts or tax increases but by "higher than expected inflation squeezing household incomes and consumption." But even with the cause of the disappointing performance still in dispute, its effect has been to drain both the government and the opposition of political authority. Mr Osborne has to face daily questions seeking to know why the economy is not improving as quickly as promised and why austerity is now scheduled to last longer than initially planned. Simon Wells, chief UK economist at HSBC, argues that such is the political difficulty of such prolonged austerity at a time of feeble growth that the government will have to reconsider whether it takes a "Tina - There Is No Alternative" approach or changes tack. He adds wryly: "It will have to decide if it is a Tina or a turner." If it is bad for the chancellor, it is worse for Ed Miliband, the Labour leader, and Ed Balls, his shadow chancellor. Labour is grappling with how to rebuild its reputation for economic credibility. Polls show they have convinced neither the public nor economists that simply slowing the pace of austerity would make everything right, leading to such a large boost in economic activity that the deficit would decline. Even though most of the public debate centres on fiscal policy, it is the adaptation to the new economic realities - the supply side of the economy that is so evidently changing for the better in Salford Quays - that matters most in the long run. The concern is that Britain's economy has been permanently hit by the financial and economic crisis. The OBR forecasts that by 2016-17, output will be 18 per cent lower than it would have been had the growth rates of 1997-2007 continued. It is this assumption of persistently low growth from the government forecaster - not the weakness in the recovery so far - that has forced ministers to prolong the planned austerity drive. There is no single explanation for the weakness in the supply side and no agreement on whether it is a temporary hangover from the recession or will be significantly longer lasting. Two sectors with high levels of productivity - oil extraction and financial intermediation - are experiencing a structural shift to become a smaller proportion of the economy, a process that undermines growth rates unless other similarly high-productivity replacements are soon found. When he toured the north-west last week, the chancellor acutely felt the pain of this adjustment. As Mr Osborne lauded AstraZeneca, the pharmaceuticals company, for opening a £63m research and development centre south of Manchester, another big local employer, Barclays Bank, announced plans to shed 422 jobs in the region. Many politicians put faith in the manufacturing sector to pull Britain out of its hole. But even if manufacturing output recovers the ground it lost in the recession, such is the rapid productivity growth in the sector that it cannot be seen as a likely source of new employment. Mike Damms, chief executive of the chamber of commerce in East Lancashire, says this means employment will have to come from elsewhere but the retail and construction sectors remain in the doldrums while house prices are flat and there will be further cuts to the public sector. "The question is," he says, "what are people going to do?" Adjustment is made all the more difficult by Britain's weak banking system, which has impaired the supply of credit, making the necessary changes to the economy more difficult. Net credit flow to non-financial companies is contracting and lending to households is stagnant. Large companies that can access funds are sitting on their hands, wary of investing in uncertain times. These impediments appear to have contributed to extremely weak productivity growth - output per person or per hour worked - since 2007 and experience suggests much of this will persist. "A lesson from studies of previous crises is that downturns associated with significant disruption to the financial sector are often characterised by large and persistent output losses," the OBR said in its recent economic forecast. Shafts of light do exist both in demand and in supply potential. The bulk of planned tax increases has already been introduced and, with a moderation in the commodities boom, pressure on household incomes is easing. Entrepreneurship continues to thrive in pockets where companies can find new markets and in multinationals taking advantage of the weaker sterling. Christmas on the high street was unexpectedly strong. But pessimists outweigh optimists by a huge margin among economists thinking about 2012. Not only is there little momentum in the wider economy but the risks of something really nasty spreading from abroad appear greater than those of a spontaneous recovery in corporate investment or household spending at a time of continuing public-sector austerity. Two years after becoming noticed for announcing a long programme of budgetary prudence, Britain is now caught in the much less exciting grind of implementation and economic adjustment.