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Hamish McRae: Business people still think Britain is a scary place

So the Budget, now only two weeks away, will apparently be billed as a budget to promote growth. The idea of Budgets being themed was developed by Gordon Brown, and if you can find them (they are tucked away in an electronic archive well away from the stuff of the current Coalition) they make amusing, if slightly sad, reading. This is from the opening passage of his final Budget in 2007:

"Mr Deputy Speaker, this Budget will set out the long-term reforms we must now make to meet the global challenges ahead, and to build a Britain of high aspiration and achievement for the years to come. I can report the British economy is today growing faster than all the other G7 economies – growth stronger this year than the euro area, stronger than Japan and stronger even than America... Before 1997 we were bottom in the G7 for national income per head – seventh out of seven, behind Germany, Italy, France, Canada and Japan. Now we are second only to America, and ahead of all these countries."

Well, we all know what happened next. But I quote that not to show his bombast and absurdity but rather to remind us all of the limits to the authority of all chancellors. Their job is to run the Government's finances as competently as possible, not "to build a Britain of high aspiration and achievement for the years to come". It is a bit early in his career cycle for George Osborne to display the same sort of hubris as his predecessor but one, but we should beware any incipient propensity to lord it over us. What we need is competence. If we get that, then we will get sustainable economic growth; if we don't, growth will be undermined.

But what is competence? Budgets affect the economy in a number of ways: they set the broad fiscal framework; they allocate funds to the different spending departments; and they set taxation levels and rules.

As far as the fiscal framework is concerned, we know with a high degree of certainty that you cannot puff up growth, except maybe in the very short term, by running large deficits. You can have an argument about how quickly to correct a deficit and about the safe limits for borrowing. But no-one thinks that huge deficits boost long-term growth. They don't think that even in Greece. So what other levers do governments have?

Start with the spending side of the Budget, which would in normal times in the UK amount to around 40 per cent of GDP. It is higher at the moment, around 47 per cent, thanks to the surge in public spending and the decline in GDP, but it was below 40 per cent for much of the early period of the previous government. But say 40 per cent; now split that into two. Roughly half of that is transfer payments: money the Government gets in tax and then pays out again in pensions, unemployment benefit and other welfare payments. It does not decide how we spend that money; it merely decides on the size of the payment. But the other chunk is money that it spends on real services: its central administrative costs but also the NHS, defence, schools, grants to local authorities and so on.

So you could say that the Chancellor directly controls 20 per cent of the economy. That is big enough to matter – it is substantially larger than manufacturing – and the legitimate demand we taxpayers can make is that this 20 per cent should be well run.

Ultimately we generate economic growth by increasing productivity. Yes, if the population rises then total GDP is likely to climb. Increasing the proportion of the population that is in work helps too, and investments abroad can bring wealth into the country. But if you are interested in income per head, the main way you increase that is by increasing the amount each person produces. Here, as far as that 20 per cent of the economy is concerned, the Government's reputation over the past decade has not been good. It is also hard to measure output in service industries but the general conclusion is that productivity in the British public service has at best stagnated, and at worst has fallen. So the first part of any growth agenda must surely be to run that part of the economy better.

There is no magic wand here: just a huge number of organisational changes, most quite modest in themselves but fiendishly hard to carry through. See the present row over police efficiency as one part of that much bigger story.

Beyond that, what else can a government do? Here there are two views. One is that well-targeted public spending can make a difference to long-term growth potential: things like training grants to help lift skill levels, or tax breaks on particular types of investment for example. But without wanting to dismiss that approach completely – the "initiative a day" policy of the previous government – I think we are now very aware of its limitations. Governments are not clever enough to micro-manage economic endeavour.

So the other view – that governments should simply get out of the way and allow growth to happen – seems to be gaining ground. But it too runs into difficulties. Governments cannot get out of the way because voters demand they intervene.

Take one simple example: a growth agenda would permit a third runway at Heathrow, as the previous government accepted, but that was not politically possible. A growth agenda would not build a new high speed railway line to Birmingham because there are other more important infrastructure investments needed ahead of that. But politics intervenes. As for the way the financial services industry is being treated... well, let's not go there, for that is another huge issue.

Finally, there is one thing that everyone agrees on. Policy should be more predictable.

Talking to business people recently, I have been troubled by their feeling that the Coalition is all over the place. Everything is being chopped and changed. There is widespread support for the broad economic objectives but the detailed application is seen as a disaster. The perception is that they are getting the macro right but the micro wrong. Britain has become a scary place to do business, more scary in some ways than it was under the previous government, at least before its final two years of meltdown.

That is not good. There is time to turn this round, for we are still in the early stages of the global growth cycle – but we need more sensitivity to the business and financial communities or we won't get our share of that growth.