Hamish McRae: When will we see value for money after the years of plenty in the public sector?

It takes time for extra resources to result in extra output
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The Independent Online

Phew! The last time we will have to listen to a Gordon Brown Budget. It is an extraordinary achievement, whatever view you take of his stewardship of the nation's finances, to have remained in the job for so long.

It is a testament in part to the economy he inherited - one that, perhaps rather to the surprise of all of us, has proved remarkably well-fitted to this ever more global economy. You could say it is also testament to the policy framework he inherited - the system of inflation targets put in place after the disaster of the exchange rate target and membership of the ERM.

But it is also testament to his own judgement. He should receive full credit for taking that monetary framework a stage further with the independence of the Bank of England, a decision that has stood the test of time remarkably well. And that Britain came through the 2000-02 global downturn in such good shape had a lot to do with the sound fiscal position of the country that he built up in his early years in office.

So why is he in the dog-house? It can't simply be a reaction to his stealth taxes, for you do have to remember that basic tax rates have not really been increased, or only by a tiny amount. It can't simply be a reaction to the increased complexity of the tax and benefits system, however infuriating that is. It can't just be the sense that a lot of the additional public spending has been wasted, though that is a serious line of attack. It can't simply be a reaction to his being in the job so long that the public want a fresh face.

But people are upset. It is not just taxpayers and small businesses that have become increasingly vocal in their criticism; big business is upset too, particularly about corporate taxation. And the civil service unions are upset, despite having seen an increase in employment, about the cut in real incomes that is now in store. Remaining supportive are the foreign companies and their managers locating in Britain, which, if you want to be cynical, might have something to do with the fact they don't pay much UK tax.

So tax must be part of it. But I think it is also a concern about value. The two graphs above help explain what has been happening to the UK on two counts: taxation and public employment.

In the left-hand graph you can see that while UK taxes are not particularly high by global standards - higher than the US, Canada, Japan and Australia but lower than France, Italy or Germany - the direction is unusual. In most countries, tax has either been flat since 1997 or come up a bit (in Spain, for example), but in Britain it has risen by nearly 3 per cent of GDP. That is a faster increase than in any other large economy.

You can see where the money has been spent in the right-hand graph: more staff. That growth, though, is now over. Tax is projected to rise a little more over the next two years but already the impact on the number of government workers of this slower growth in revenues is being felt. That surge in employment was quite extraordinary - no other country in the world experienced anything like it during this period. The task now will be to ensure that extra output is extracted from these extra employees.

This is a task that will be explicitly outlined in the Budget, and that seems to me the single most important thing to look for in Wednesday's speech. The Chancellor has form here. You may recall that part of his pitch in the last Budget was the rise in the output of public services that would come as a result of greater efficiency. You may not remember the assumptions about the amount of increased output but I can tell you they were pretty tough. You may remember the phrase "front-line services": that is where the resources were supposed to be redirected.

Let's see what he says this time, but more important, let's have a look at the detail of the numbers. What he does is always more important than what he says. With all Chancellors there is a disjunc- tion between the two, but with this one it is larger than normal.

How people react to that lump on the right-hand graph will determine the outcome of the next general election - assuming Mr Brown does indeed become the next prime minister. It is intellectually lazy to hold that an increase in public sector employment must be a waste of money, just as it is lazy to argue that public sector provision of services is somehow morally superior to private sector provision. Further, there is some reason to believe that it takes a while for additional resources to result in additional output.

Think of the investment by the private sector in IT ahead of the millennium. Ostensibly much of that appeared to be wasted, but subsequently the investment seems to have yielded large increases in productivity. Until you get the kit in and have some experience using it, you don't fully understand how to extract the most from the investment.

That is surely the challenge not just for a Brown government but for whoever comes after it. Improving the quality of output in the public sector is not a two- or three-year job; it will go on for a decade. There is no point saying Mr Brown has blown a huge amount of taxpayers' money. Even if that is true, it does not solve the problem. We have to work from where we are now.

It is possible to have some sympathy with his critics. For example, Ruth Lea, director of the Centre for Policy Studies and a governor of the London School of Economics, has just produced a note for the Budget. It points out that after 13 years of continuous growth, public finances should not be so firmly in the red, and argues that Mr Brown is "a true tax 'n' spend Chancellor and, sadly, to so little effect".

The Conservative Party's Small Business Task Force has concluded that state business support tops £12bn but with no evidence that the money has any impact. This report was written by independent small business experts and was led by Doug Richard, chairman of Library House and a former member of BBC2's Dragons' Den, so it is not pure anti-Labour politics.

What matters now, however, is the future. Public spending as a percentage of GDP will almost certainly have to come down over the next decade. Taxation will probably have to come down eventually, though most independent economists believe that in the short term it may have to go up. The UK is no longer a low-tax country; it is middle of the pack. That has been the result of a political choice made by Mr Brown to push taxes up to this level. The task ahead is to reconfigure government activities so as to ensure we get value for money for that. The country starts on this path with the Budget this week.

They stuck their necks out. Let's hope bears don't bite them off

When market commentators get things right, they deserve a bit of attention. Last week was another bumpy one for world share prices, so it is nice to be able to record that two boutique economic advisers warned of the turbulence.

One was the Bank Credit Analyst (BCA) group in Montreal, which put out a note on Tuesday morning - the day Wall Street slipped sharply in final trading - saying that another dip was very likely.

The other was Longview Economics, based here in London (but also writing about the US markets), which on the previous Friday had warned: "Another wave of selling of risk assets is highly likely in this wave of risk aversion (and will probably start next week)."

You can't get much more explicit than that - as close to a bullseye as anyone could ask for. So I was intrigued to see what Longview's chief economist, Chris Watling, had to say on Friday about what happens next. Be cheered for he starts:

"One of the many reasons that we do not expect this sell-off to degenerate into a bear market (ie, meaningfully break the long- term trend line) is the robust health of the corporate sector. A strong and low-risk corporate sector implies a low-volatility (ie, low risk) equity market."

We are not completely in the clear yet, though. He warns of a further wave of selling in the next one to three weeks. But that will be temporary. Then markets will become calmer and the bull market in American shares can resume through the summer and autumn.

The method behind the approach of BCA and Longview is to look at investors' appetite for risk. This is the extent to which the quest for higher returns makes them ignore the risks they are taking on, before being squashed into a "flight for quality" when something such as the collapse in the low-grade mortgage market occurs. Once these shocks have been absorbed, the market can resume - provided there is no fundamental weakness.

And that is the key point. Is there any fundamental reason for US share weakness? If you believe American shares are fairly priced - that companies are not carrying too much debt and the imbalances in the US economy are gradually being corrected - then it is hard to see why the bull market should end yet. Intuitively, that makes sense. But let's see what happens in the next three weeks and meanwhile admire the "neck-sticker-outers" who got the last break right.