Hamish McRae: Our future is out of our hands

The tools government has to influence the economy are far less effective than before
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The Independent Online

So the manifestos are unrolled: our politicians declare what they will seek, if elected, to do. But if there seems a certain unreality about both the Labour and Conservative offerings, and I expect the Liberal Democrat one today, it is because the economic assumptions that all the politicians are making are no longer valid. In particular, they fail to come to terms with two things.

One is the relative decline in the importance of the British economy and the ineffectiveness of government to change that. The other is that the tools that a government has to influence an economy are much less effective now than they were a decade or more ago. Politicians can pull the levers of power – they can pass laws or set up spending programmes – but not much happens as a result.

The global shift first. Ten years ago the UK was the fourth-largest economy in the world after the US, Japan and Germany. Now it is the fifth, having been passed by China in 2005. In another 10 years there is a reasonable possibility that we will be the sixth, having been passed by India. This is not to attack this Government for its economic management. It is simply to point out that all the larger European countries, and to some extent the US, are losing ground to the BRICs, that acronym invented by Goldman Sachs to encompass the four largest emerging economies – Brazil, Russia, India and China. That shift of wealth is probably inevitable and surely something to be welcomed. It must, in any sense of human values, be right for wealth to be spread more evenly around the world. Why should people in China and India not benefit from economic growth, assuming that it can be delivered in an environmentally sustainable way?

But with a shift of wealth goes a shift in power. This country will inevitably become less important in the world. So too will the other European nations; so too will Japan – indeed that is already evident – and gradually even the US.

This changes the way we will see ourselves but also the ways in which we can deploy our influence. Obviously there will have to be much more co-operation and much less unilateral action. Less obviously, it will lead to a redirection of diplomatic effort. It will mean, for example, that Britain's relationship with India (already the second-largest investor here after the US) will become more important relative to the US and the European Union. For example, it looks as though the biggest public share flotation in London for years will be not for a European or American company, but for Essar Energy, India's second-largest power group.

What matters most for British prosperity over the next decade will be how we manage our trade and investment relationships with the new economic powers. Yes, we have to trade as effectively as possible with Europe and the US, for they remain huge markets. But that is not where the future will be. Within the next five years, the size of the European workforce will start to shrink (it is already falling in Germany) and shrinking workforces mean shrinking purchasing power.

In Asia, by contrast, the boom will continue for another generation. Yet all the debate from politicians about the economy has been in a purely British context. We will tax our banks; we will bring in some incentives for small businesses; we want a smaller financial sector, and so on.

In any case – and this is the second reason for the unreality – the levers that governments can pull don't work any more, or at least not very well. Take fiscal policy. Had anyone said five years ago that the public-sector deficit would be 12 per cent of gross domestic product, they would not only have been thought to be off their rocker but it would be assumed that a deficit on that scale would give a huge boost to the economy. Well, we have it and not much is happening. Take monetary policy. If anyone had predicted that interest rates would be 0.5 per cent, that too would have been thought absurd. But it would also have been assumed that cheap money would have led to a boom in house prices, whereas they seem to be falling again.

If the big macro-economic levers don't work, what about the smaller, more precise levers governments pull? The last Government tried to be more effective by using targets for public-sector performance. But these have been disappointing at best and, at worst, have distorted behaviour, pushed up administrative costs and decreased productivity. In any case, the experiment of increasing public spending by a huge amount is over. There is nothing in the kitty.

Legislation and regulation? Well, there has certainly been plenty of both, for the boom in new laws predates the Labour governments. But again the effectiveness has been questionable. You can push a Bill through Parliament but you may simply create more court cases, or worse, a distrust of both the law and the political process. You can bring in new legislation on migration but the administrative ability to enforce it is lacking, or "not fit for purpose". You can bring in new regulations but that increases the compliance costs and again may distort the outcomes. Besides, you may get regulation wrong. It is an obvious point, but the new system of financial regulation established in 1997 has not been a triumph.

The reality is that our next government, like any government in any Western democracy, will be much weaker than politicians now pretend. It will be weaker because Britain is becoming less important and it will be weaker because the levers at its disposal are less effective. But politicians can hardly bear to say that. There was a little hint from William Hague on the Today programme yesterday, but in general from all major parties the message is still: "vote for us and we will do this or that for you".

To say all this is not to be pessimistic about the future of the UK. We have, as a people, an extremely interesting hand of cards to play in this ever more global world economy: commercial, cultural and indeed financial. But it is a hand that has to be played sensitively, cautiously and modestly and it is not, I am afraid, as strong a hand as it appeared 10 years ago – or indeed as is implied by the politicians. Instinctively we all know this. Don't we?