Outlook: Economics of war against Iraq look grimmer by the day

Back to Boots; Executive pay Â

A couple of months back a senior Bush aide told me: "If we are still fighting after a month with no end in sight, then we are in trouble. But I don't think that's at all likely." It's still too early to say definitively that the allied campaign is in trouble. But that virtually nothing is going to plan is not in doubt. The war is now likely to take longer than anticipated, it will require more fire power than planned for, the resistance is stronger, the liberated less welcoming than they were supposed to be, and the collateral damage worse.

The ultimate outcome is still not in doubt, but prospects of a swift resolution are fast receding. Nothing is certain in war, and the situation may have turned on a sixpence by this time tomorrow. Even so, it is already clear that military planners badly underestimated the difficulties and, as a result, policy makers are preparing themselves for the worse – a protracted war.

I'm not sure the markets have yet fully appreciated the significance of this change, or its manifestations in the order to deploy more troops. It could take anything up to a month to get all the reinforcements now being sent to the Gulf in situ, and if the final assault on Baghdad doesn't occur until then, that's a much longer engagement than anyone had thought likely. What does this mean for markets and the wider economy?

However hard you try, it's impossible to find anything positive to say about it. President George Bush's request this week for $75bn of additional funding was predicated on a 30-day campaign. That figure won't double if the war takes twice as long, but the costs are already rising fast, witness our own Chancellor's announcement yesterday that he is increasing Britain's war provision by £1.25bn to £3bn. Even £3bn is a drop in the ocean of total government spending projected at £405bn this financial year. But it is less on the expenditure side of the ledger that the war will work its damage as on the income account.

Recent figures on the public finances showed that business and income tax receipts are falling at their fastest rate since the last recession as the economy slows. Business confidence was already rock bottom, even before the war started, and there were clear signs of consumer confidence beginning to slip too. What little growth there is in the economy is coming mainly from the public sector.

According to figures released yesterday, the public sector grew by 3.8 per cent last year, but overall growth was only 1.8 per cent. Keynes would say that's as it should be, with the public sector spending the economy out of recession. But in the end, someone has to pay the taxes that enable the spending, and I doubt whether there is any growth at all going on in the private sector right now, with everyone glued to the grim news coming out of Iraq.

If the chances of recession in Britain have grown considerably over the past week, it's even worse in the US, where the once implausible possibility of a double dip recession once more looms large. The Federal Reserve would already be cutting interest rates further to support the economy, I would suggest, but for the fact that policy action of this sort might be misread as panic and defeatism.

Here in Britain, one of the Monetary Policy Committee's more dovish members, Marian Bell, yesterday suggested that the present steep though probably temporary uptick in inflation was no barrier to further rate cuts if that's what the economy needs. She may have to pull the lever earlier than she thinks.

Back to Boots

The worldly wise John McGrath, chairman of Boots, was in characteristically blunt form yesterday when he announced the company's latest profit warning. Here's Mr McGrath on the contention that Boots doesn't seem to be much good at anything other than its core Boots the Chemist high street business: "Yup, the history does rather support that analysis." And the suggestion that even the core business may have gone ex-growth? "The business isn't mature. It is the managers who are mature."

Ever since I've been in financial journalism, Boots has been a company struggling with an inner torture that there must be more to life than running a chain of chemists, albeit the world's biggest and most successful example of the genre. Eventually it recruited an engineer, Sir James Blythe, to spearhead the diversifications the board thought were needed to build on the company's high street success. The result was predictably disastrous, and were it not for the strength of the underlying brand, the attempt to build a retail conglomerate with interests in businesses as diverse as children's clothing and motor accessories might have sunk the company.

By comparison, Stephen Russell's bid for pharmacy freedom has been relatively harmless. He dreamt of new formats, an online healthcare supermarket and, through the company's Wellbeing concept, expanding into healthcare and lifestyle services, from dentistry to aromatherapy. By the end it was all looking like a Botox injection gone wrong, and by closing Wellbeing, Pure Beauty and what's left of the overseas operation, Boots will be lancing losses of about £40m a year. The fact that Wellbeing and Pure Beauty last year generated just £20m of sales shows just how misconceived they always were.

Mr Russell has already paid for them with his job. He'll be going as soon as the company has found itself a new chief executive. Mr McGrath has already performed the sweep out, but there's plenty left for the new man to do. Mr McGrath insists that Boots is still in a growth market, with health and beauty spending rising by 4 to 5 per cent a year and pharmacy spending by 7 to 8 per cent. Nearly 40 per cent of sales at Boots are own-label, which Mr McGrath thinks sufficient product differentiation to keep the supermarkets at bay. I'm not so sure. Net margins of over 12 per cent, and gross margins so embarrassingly high that the company won't admit what they are, look indefensible on any long-term view.

Going back to basics looks eminently sensible when the basics are so successful. The problem is keeping them that way.

Executive pay

It's hard to know what more to write about executive pay excess, other than that it seems completely unstoppable. The examples of it unveiled in the BAE Systems annual report yesterday seem comparatively minor set against recent instances, but they do make you wonder just what directors have to do to deserve a pay cut. In a year when the company lost £616m and the share price fell two-thirds, the chief executive, Mike Turner, received a bonus amounting to 24 per cent of his basic salary.

Mr Turner cannot be held wholly accountable for the disaster the company has become, as he only took up the post last March. His predecessor, John Weston, presumably can, but for his two to three months of work for the company last year he received £130,000, his pay-off was £520,000, and he retires at the ripe old age of 51 on a company pension of £166,000 a year, which assuming he lives another 30 years would effectively cost the company £5m.No wonder Mr Weston took his punishment with such gentlemanly good grace.

It's impossible to know whether the Higgs reforms will succeed in reining in this culture of undeserved boardroom excess. At a time when companies are closing their final- salary pension schemes or asking their employees to take reduced benefits, directors are continuing to fill their pockets from the till in a manner which displays an almost total disregard for the responsibilities of leadership.

By all means reward success and achievement, but if the Higgs proposals can stop this pervasive culture of unaccountable boardroom greed, they will have served some purpose.

jeremy.warner@independent.co.uk