Hamish McRae: One problem the Chancellor can't brush off

Discussion of Britain's poor productivity performance is like wrestling with a jelly

Gordon Brown faces a disagreeable day today. His fiscal plans are being scrutinised by the Treasury Select Committee and the Institute for Fiscal Studies (IFS). Both are likely to conclude that he is being over-optimistic about the state of the country's finances.

The select committee is expected to question whether the efficiency targets for the public sector are realistic. The IFS is expected to argue that despite recent increases in taxation (mainly on companies), the Chancellor will have to raise taxes still further if he is to fund his long-term spending commitments.

He will brush it off. But whereas a couple of years ago it was credible to ignore the occasional missed target, it is becoming harder and harder to do so. The problem for the critics is that the deterioration is progressive rather than catastrophic. Thus just last week there was new data suggesting that the (increased) borrowing target for this year that he gave in the pre-Budget report is likely to be overshot by a couple of billions. So in less than two months, it looks as though his numbers have slipped a bit further. But it is "only" a couple of billion, and he can massage the figures to make it appear that he is still meeting his own rules, even if the European Commission thinks he is not meeting its ones.

And there are plus points to UK economic performance. It may be that 2006 will be the first year since the euro was introduced that Britain grows more slowly than the eurozone. But this week new figures showed that last year the UK attracted more inward foreign investment than any other country.

It was a bit of a freak because the figures were distorted by the full merger of the Dutch and British sides of Shell. Still the wider point stands that there has, as yet, been no significant fall-off in international business confidence in the UK. Companies may grouse, for example over increased North Sea oil taxation. But as long as they keep coming here, that is evidence of their support. The Chancellor deserves credit for maintaining that confidence.

When the Chancellor's political obituaries are written I suspect that he will be criticised less for his macro-economic management than for his failure to tackle the endemic problem of UK productivity. Indeed in the part of the economy over which he has direct control, he has demonstrably made it worse.

Discussion of Britain's poor productivity performance is like wrestling with a jelly. Overall we know that UK productivity is poor by US standards, but then so too is all Europe's. We have narrowed the gap in living standards with the rest of Europe, and in most cases eliminated it. But that is partly because we work longer hours than most of Europe (though short hours compared with the US and Japan), and we have a high proportion of the workforce in jobs.

But when you look at specific industries, the problem slithers away. Manufacturing? Some UK plants are wonderfully efficient: Nissan in Sunderland, for example. Services? At the high end, such as financial and legal services, the earnings are huge, and people would not get paid if they were not satisfying their clients.

Besides, sometimes increasing productivity simply delivers a worse service. If stations are not staffed at night, that increases the efficiency of the railway, but it certainly does not improve the safety or well-being of the passengers. It is always very hard to measure quality in services. A UK supermarket is probably less efficient than a US one, but the food is fresher and there are fewer chemicals in the stuff. Fresh food needs more careful handling and this means that the productivity is lower.

My own judgement is that in the private sector there is some sort of problem, but it is very hard to pin it down. There may be some problem of labour force skills, but if that is so, why is US productivity so much higher than European ones, when education levels are no higher - and arguably lower?

There is almost certainly a British management element in manufacturing, for the best foreign-owned companies in the UK achieve better productivity levels than UK ones. There seems, too, to be a particular problem in the construction industry. And we may be slower than the US (though faster than much of Europe) in extracting increases in productivity from applying IT.

On the other hand, in some high-end services the UK has probably the highest productivity in the world - if you measure the output of the people in the City by the amount they earn. Partly as a result of the service-orientation of the south-east of England, it has very high productivity by world standards, whereas much of the rest of the country is poor.

So we are uneven. We are uneven by sector; we are uneven within sectors; and we are uneven geographically. The Chancellor knowsthis. The Treasury is scouring the world to try to see what it can learn from other countries. And all sorts of "initiatives" - to increase R&D, to improve training, to boost IT application - have been tried. The US, which does not have such a top-down method of government, meanwhile continues to stride ahead. Or at least it does in the private sector, for no one believes that it has a particularly efficient public sector.

Nor, sadly, do we. And that is the area where Gordon Brown has been most disappointing. Insofar as we can believe the figures, public sector productivity has plunged. To say that is not to get into an ideological debate about the relative merits of public and private provision. That is a related but separate area for discussion. It is simply to point out that the figures show falling productivity in the public sector, most notably in areas where spending has increased fastest, such as the NHS. Total public spending is 40 per cent of GDP, half of which is output, and half transfer payments. That output is bigger than manufacturing and big enough to drag down the productivity performance of the whole economy.

What seems to have happened is that additional resources have been given to the public sector without proper scrutiny. Instead of trying to create a culture of efficiency, control is by audit after the event. This does not work. It is a huge trap and the Chancellor has fallen into it. Why?

Well, I think when the political obits are written, they will conclude that while Gordon Brown is wonderfully intelligent and has worked very hard to do his job well, like Tony Blair he has no experience of management. He is not good at listening to people who disagree with him, the core of good management, and he tries instead to micro-manage every detail of public spending. The irony is that on his chosen battleground - the need to boost national productivity - he has had his worst defeat.