If Alistair Darling was expecting to be garlanded by business after his pre-budget report last week, he will have been disappointed.

Ahead of it, the chancellor had been urged by firms to do something to prevent the recession turning into a depression. This he duly did, announcing a £20 billion “giveaway” package, built round a temporary cut in Vat from 17.5% to 15% and bringing forward some £3 billion of the government’s capital spending programme.

Darling also bowed to demands from companies to reform the taxation of foreign profits, boost the flow of lending and support small businesses, and defer a series of proposed tax changes, including a rise in the small companies’ corporation tax rate.

Perhaps business was dismayed that Darling’s statement had a big sting in its tail; a 0.5% rise in employer and employee National Insurance contributions and a new top rate of income tax of 45% from 2011.

Maybe it was the sheer scale of the borrowing and debt problems revealed by the Treasury’s new projections, with borrowing set to top £118 billion next year and public-sector debt on course to double to more than £1 trillion.

The response was one of scepticism and unease rather than delight. Even those who had called for a big giveaway were unsure about whether this was the right one. Miles Templeman of the Institute of Directors got the £20 billion boost he was looking for but was worried that by focusing on Vat the chancellor would not get enough “bang for the buck”.

Richard Lambert, director-general of the CBI, was concerned about the absence of a framework for getting government borrowing down, which over the next five years will be £300 billion higher than the Treasury had expected in the budget only eight months ago. Darling and his officials, who were considering until last weekend a range of options, including a programme of pre-announced Vat rises to follow the emergency cut, knew that whatever short-term tax changes they announced last Monday, the big story was the sudden and alarming deterioration in the public finances.

The chancellor faced the possibility of announcing no new measures to get the economy through the recession, yet still unveiling a rise in borrowing to more than £100 billion next year. Politically and economically that would have been unpalatable, particularly in the context of Gordon Brown’s championing of global action to boost the world economy.

However, while announcing a short-term stimulus got Darling past his immediate problem, officials know the hard job in the long term will be reining back record levels of borrowing. Many in business recognise this. “I’m not sure the government’s fiscal stimulus is worth the price of getting further into debt,” said Hugh Osmond, financier and owner of Pearl Assurance. “Clearly they had to rescue the banks but a 2.5% cut in Vat is irrelevant, even if it’s passed on.”

Tim Martin, chairman and founder of JD Wetherspoon, said: “Everyone knows that the root of the problems is excessive borrowing. What worries me is that the solution that’s been proposed to solve the problem is more borrowing, on a quite unprecedented scale. I hope what they are doing works, I really do, but I worry they may be storing up trouble for the future.”

Dermot Halpin, president for Europe, Middle East and Africa of Expedia, the travel agent, said: “Governments don’t seem able to influence events. The only thing you can be sure of is that you will be in debt and paying this off for the next five years. If UK Inc was a business they would be going back over the cost base.” A survey of directors of FTSE 100 and FTSE 250 firms, carried out by Price Waterhouse Coopers in the wake of the prebudget report, also revealed widespread scepticism. While 22% said the measures would help their business, a similar proportion said they would make things worse.

Though only 12% of firms said the outlook for their business over the next 12 months was for severe retrenchment, 37% said they would be undertaking “mild belt-tightening” and 28% said they faced a year of stagnation. That is what the government, which needs growth to come back fast, hopes to avoid.

WHILE Darling was announcing his fiscal package, other countries were also preparing to take action. In Brussels, the European Commission called for an EU fiscal stimulus of €200 billion (£165 billion), or 1.5% of gross domestic product.

The commission president, Jose Manuel Barroso, acknowledged that member states would decide their own levels of stimulus. “It is necessary to act in a coordinated fashion, but that does not mean a uniform fashion. The measures member states are taking should not be identical, but they should be coordinated,” he said.

It quickly became clear, though, that countries were divided on how to provide the boost, with France and Germany rejecting an emergency Vat cut. But it is to America that many are looking for a lead.

On Monday president-elect Barack Obama confirmed Timothy Geithner, president of the Federal Reserve Bank of New York, as his Treasury secretary. Geithner is a close ally of Hank Paulson, the current Treasury boss, and has been a key player in the bailouts of the American financial system.

Geithner’s mentor Larry Summers, Harvard economist and Clinton-era Treasury secretary, is to head the White House Economic Council. Paul Volcker, 81, a former chairman of the Federal Reserve under presidents Carter and Reagan, was appointed to lead the economic advisory board.

At a press conference the usually cool Obama bristled at suggestions that he was recycling the Clinton administration’s economics team.

“What we are going to do is combine experience with fresh thinking,” Obama said, speaking at his third news conference in three days. “But understand where the vision for change comes from first and foremost – it comes from me.”

Some of that vision was outlined in his weekly radio address when Obama said he would direct his economic team to draw up a two-year stimulus plan with the goal of saving or creating 2.5m jobs. “A plan big enough to meet the challenges we face”, was how Obama described it.

Obama was speaking as yet another American financial giant teetered on the edge of collapse. The US government was forced to bail out Citigroup, once the world’s most valuable financial-services firm. Citi’s shares had plummeted 60% in the previous week on fears that its portfolio of dodgy debt investments would sink the company.

Before the stock markets opened on Monday the US authorities loaned Citi $20 billion on top of the $25 billion it had already received and said they would guarantee a further $305 billion of assets.

Obama said he hoped to sign the stimulus package into law soon after taking office on January 20. “The news this week has only reinforced the fact that we are facing an economic crisis of historic proportions,” he said.

Obama’s package will be “a two-year, nationwide effort to jump-start job creation in America and lay the foundation for a strong and growing economy. We’ll put people back to work rebuilding our crumbling roads and bridges, modernising schools that are failing our children, and building wind farms and solar panels, fuel-efficient cars and the alternative energy technologies that can free us from our dependence on foreign oil and keep our economy competitive in the years ahead,” he said.

Estimates for the cost of Obama’s latest proposal vary between $300 billion and $700 billion, far beyond the $175 billion stimulus plan he proposed in October.

It comes on top of $152 billion in tax cuts and economic incentives that outgoing president George Bush approved earlier this year.

The numbers are big. In comparison, the Vietnam war cost America an inflation-adjusted $698 billion, the so-called War on Terror declared after September 11 has so far cost $597 billion and the New Deal, the economic stimulus package announced by president Franklin Delano Roosevelt after the Great Depression, cost $500 billion in today’s money.

The US government has already committed an unprecedented amount of money to stabilising the financial system. Some $700 billion has been pledged to rescue America’s financial institutions under the Troubled Asset Relief Program. But so far Tarp has failed to restart credit markets as financial firms have shied away from making new loans.

Last week the Federal Reserve and Treasury department unveiled a plan to pump $800 billion more into the American economy in an attempt to jump-start lending by banks to consumers and small businesses.

“There are no quick or easy fixes to this crisis, which has been many years in the making,” Obama said last week. Many agree. Until the banks are properly fixed, the crisis will continue.

THE past few days have seen a torrent of government rebukes to Britain’s biggest banks. Gordon Brown declared that all banks should freeze overdraft fees, following the example set by Royal Bank of Scotland.

Darling then warned he was “ready to take further action to make sure that bank lending resumes”. Treasury officials were briefing that this could see full nationalisation of banks if necessary, or a new regulatory system that would, in effect, allow the government to control banks’ profit margins.

Lord Mandelson, the business secretary, has pleaded with lenders “not to be unreasonable” in their dealings with customers.

The politicians’ argument is straightforward: banks have received £37 billion of taxpayers’ money and so should be forced to lend that money to cash-strapped consumers. If only it were that simple.

One problem is that the banks have not yet received a penny of the new money. Even if they had, these funds were always intended as a safety buffer against losses, not funding for the economy.

“The government is deliberately creating a lot of confusion about what that money was for,” said one senior banker. “Their argument at the time was that we needed additional capital to absorb all the losses they expect us to receive as we go through the recession. If we were to lend all that money out again to businesses and consumers, we would be back at square one.”

The government’s position is contradictory. Banks are being blamed for making reckless lending decisions in the past but at the same time are told to lend into a falling economy.

“Almost all lending to individuals and small businesses is done through credit-scoring models,” said Sandy Chen, an analyst at Panmure Gordon. “ Those models have all changed in light of the different outlook for the economy and they are telling the banks to lend less and tighten credit.

“There is a risk that if the government forces this issue there will be a much larger increase in bad debts 6 to 12 months down the line.”

While bashing banks has made for good political sport, behind the scenes the government has been less combative.

“In all the meetings we’ve had with all branches of government they have been fairly supportive, particularly Mandelson,” said one bank executive.

“We’ve been told that they don’t think there’s a huge issue yet, but because there’s a perception that there’s an issue they have to do something about it. And what they have been doing is blaming us for everything, so that history will record that this was all the fault of British banks rather than anyone in Downing Street.”

As a condition of the government bailout, Royal Bank of Scotland, Lloyds TSB and HBOS agreed to maintain lending at 2007 levels to homeowners and small businesses.

The big banks have been falling over themselves to show that not only are they doing this, but they are going beyond the call of duty.

In a terse letter published in The Times last week, Eric Daniels, chief executive of Lloyds TSB, pointed out that his bank has increased its lending to the small-business sector by 18% in the year to date.

RBS said it grew its loans to small businesses by 12% in the first nine months of the year. Figures produced by the British Bankers’ Association (BBA) have shown that total loans issued by all UK banks to small businesses increased 10% in the 12 months to September, reaching almost £45 billion. Overdraft borrowings increased 4% to £9.3 billion.

Even bankers admit these figures don’t tell the whole story. Anecdotal evidence suggests much of this money is being lent on quite different terms to 12 months ago, with higher charges and interest rates.

There have also been suggestions that the figures are being skewed by cash-strapped companies drawing down from loan facilities the banks are legally obliged to honour. And business-lobby groups claim rejections for loans are soaring, with banks lending only to their most favoured customers.

Yet even if the banks were to pump further billions into lending to small businesses and consumers there would still be an enormous funding gap in the UK economy.

Over the past decade there has been an explosion in credit, with a flood of new companies offering loans to consumers. Most of these businesses funded themselves by borrowing money from the wholesale money markets, much as Northern Rock did.

Everything from mortgages to credit-card debts to multi-billion loans given to private-equity companies were packaged up into bonds and sold to hedge funds, pension funds and other large institutions.

These sources of credit soaked up roughly half of all lending in the UK economy. According to the most recent figures from the Bank of England, about £740 billion of lending to the economy has been provided by the wholesale money markets.

No amount of government pressure on British banks will persuade these investors back into the market.

Building societies, which accounted for about £77 billion of mortgage lending in 2007, according to analysts at UBS, have also scaled back their lending thanks to the credit crunch.

“The witch-hunt against banks is misdirected,” said John Greenwood, chief economist at Invesco. “With the collapse of the shadow banking industry -principally SIVs, conduits, investment banks and leveraged credit hedge funds -the availability of securitised credit has virtually evaporated. It is completely unrealistic to think that high street banks (and building societies) could replace all that lending.”

The lack of wholesale funding has been partly replaced by funds from the Bank of England, but that only goes so far. It is estimated that about £120 billion has been loaned to the banking system through short-term fund lines established by the Bank. That still leaves the system more than £600 billion short of 2007 funding levels.

Nationalising the banks completely would be a bold political gesture but would not create any new money. Britain’s big banks are larger than many in other European countries. If RBS alone were to be nationalised, Britain’s debt-to-GDP ratio would soar from just below 50% to about 86%.

“You can’t lend what you don’t have,” said BBA chief executive Angela Knight. “I am concerned that a broad range of credit providers have withdrawn from the market and that this has not been properly recognised in the debate.”

The squeeze is real. A survey today by the Engineering Employers’ Federation shows not only a sharp downturn in business activity but also a big drop in credit availability. For firms it is a double whammy. And it hurts.

DARLING’S CHANGES

THE backdrop to Alistair Darling’s prebudget report was the biggest downgrade on record by the Treasury of the growth outlook.

GROWTH The Treasury now thinks the economy will shrink by between 0.75% and 1.25% next year, having in the March budget expected growth of between 2.25% and 2.75%. Recovery will come in 2010, it says, with the economy growing by between 1.5% and 2%.

PUBLIC-SECTOR BORROWING By 2010, however, the damage will have been done to the public finances. In March the Treasury expected public-sector net borrowing of £38 billion in the 2009-10 fiscal year; now it expects £118 billion.

THE GIVEAWAY The “giveaway” announced by the chancellor has to be short-lived. It is worth £20 billion between now and April 2010, £12.4 billion of which comes from the temporary reduction in Vat from 17.5% to 15%, effective tomorrow. Other big elements included £2.9 billion from bringing forward capital spending and a further £2.9 billion from rolling over the increase in tax allowances announced in July to compensate losers from the abolition of the 10p rate of income tax.

CORPORATION TAX AND DUTY CHANGES Other temporary measures, which cost the Exchequer smaller amounts, include postponing next year’s planned rise in the small companies’ corporation tax rate until April 2010, deferring the proposed clampdown on so-called income shifting, delaying vehicle excise-duty changes for older cars and boosting pension credits and the child tax credit. A shake-up of the foreign profits’ regime, which business had pushed for, brings extra revenue into the Treasury in the short term but costs £275m a year

NATIONAL INSURANCE The Treasury had promised a plan for getting the public finances back on track over the medium term but Darling’s measures barely scratched at the surface of a £300 billion rise in public borrowing over five years.

Employer and employee National Insurance contributions will rise by 0.5% from April 2011, raising £5.4 billion a year. A new 45% income-tax rate on earnings above £150,000, combined with a cut in tax allowances for those earning more than £100,000 will bring in £2 billion in 2011-12.

PUBLIC SPENDING Growth in public spending will slow over the medium term. Calculations by the Institute for Fiscal Studies suggest that current spending, on salaries and other outgoings, will be 1.7% lower by 2012-13 as a result of the prebudget report. Capital spending will be 16.5% lower. The short-term boost to infrastructure spending will be at the expense of a longer-term squeeze.

Explore Economics

• Pre-Budget Report 2008

• Budget 2009

• World Economic Forum

• The Times MPC

Times Recommends

• C&G axed - 1,660 jobs to be lost
• UK house prices rise 1.1% as buyers return
• Mixed reaction to US banks repaying bailouts