Within a month of taking office, the Chancellor transferred responsibility for monetary policy (interest rates) to the newly created Monetary Policy Committee (MPC), which was charged with meeting the inflation target. This effectively removed from government day-to-day control over economic activity. This move brought the UK into line with practice in Europe and the US and gave credibility to the government’s low inflation policy.

To emphasise that this government was committed to stability and prudence, Mr Brown also imposed constraints on his freedom to act in the fiscal area.

Aware of Labour’s reputation as a ‘tax and spend’ party, he set two rules for fiscal policy relating to total debt and public sector spending which are even more rigorous than the Maastricht Convergence criteria for single currency qualification.

The Chancellor's moves on taking office have not only underpinned the government’s reputation for sound economic management, but also gave the Chancellor the scope to focus on longer-term issues.

Whilst the over-riding priority remained ‘delivering macroeconomic stability’, Mr Brown regarded this as a necessary condition for raising Britain’s long-term growth potential.

Having given to the MPC responsibility for short-term macroeconomic management, Mr Brown and his successor could address the key supply-side issue of why the UK’s trend rate of growth is a modest 2.5%.

If the non-inflationary rate of growth can be raised to (say) 3%, this would be worth almost an additional £6 billion a year, equivalent to a 2p cut in the basic rate of income tax or an extra 10% spending on the National Health Service.

In keeping with his general approach to policymaking, Mr Brown’s objectives for his supply side reforms were very transparent.

Every autumn, the Treasury publishes a Pre-Budget Report which provides a progress report on what the government has achieved so far and the next stage of initiatives which will feature in the Budget the following March.

This is now, in effect, the government’s industrial policy. Like the Conservatives in the 1990s, it does not target specific industries. The idea of strategically important sectors or national champions is long gone.

Instead, the emphasis is on ‘framework’ policies which will help raise performance across the board. The government’s tax policies will be shaped to help achieve these objectives.

In the 2006 Pre-Budget report, for example, a series of recurring priorities (a mix of economic and social objectives) of microeconomic reform was identified:

• meeting the productivity challenge;
• increasing employment opportunity for all;
• building a fairer society;
• protecting the environment;
• delivering high quality public services.

By 2007, the priorities were extended to include ‘Stronger communities and a better quality of life’ and in 2008, not surprisingly, ‘Ensuring financial stability’ was added to the list. All of the micro objectives are underpinned by the over-riding need to ‘Maintain macroeconomic stability’.

Productivity is the main driver of economic growth and it is an area in which UK businesses have failed to keep pace with our major international competitors.

The reasons most commonly cited for this are:

• a lack of domestic competition;
• insufficient incentives and opportunities for enterprise and innovation;
• poor skills; and
• under investment.

Table 5.1: International Comparisons of Productivity (UK = 100)

At a time when labour markets are tightening and there is upward pressure on earnings, businesses will need to focus on productivity to raise output and efficiency. Too often, companies have believed larger business volumes mean more labour, but this attitude needs to change.

In a low inflation environment, few firms will be able to pass higher labour costs on to customers as higher prices. The responsibility to change, in the Treasury’s opinion, is shared effort on the part of government, management and unions.

Productivity can be measured in various ways but it is essentially the relationship between inputs and outputs, in other words, for a given set of inputs, how much can be produced or, alternatively, to achieve a given level of output, what inputs are required.

As such, the focus is often on labour productivity, in terms of output per worker or output per hour.

Businesses are constantly seeking ways of being more efficient, of finding a better balance between inputs and outputs (or between costs and income). This is clearly the major determinant of unit costs and therefore selling prices (and hence demand).

In the UK, manufacturing, perhaps because of the pressure of global competition, has a better productivity record than services, particularly since 1990.

According to the Treasury, there are five key elements to improving productivity performance on which progress had already been made, namely:

Improving competition

This is to promote flexible markets and increase business efficiency and consumer choice.

Promoting enterprise

This will ensure that UK business is well placed to respond to opportunities in a rapidly changing global market.

Raising UK skills

This is to create a more productive and flexible workforce and to meet the long-term challenges and opportunities presented by emerging markets.

Supporting science and innovation

This is seen as central to success in the international economy, as global restructuring focuses developed economies toward knowledge-based and high value-added sectors.

Encouraging investment

To increase the stock of physical capital supported by stronger, more efficient capital markets. In the global economy, attracting international capital and investment will require macroeconomic stability and a robust and efficient investment environment.

Measures to increase productivity

The 2006 Pre-Budget Report spells out the next steps the government is taking to strengthen the drivers of productivity growth. They include:

• investing in the growth of the UK’s science and innovation system through a single health research fund of £1 billion;
• enabling greater flexibility in the land use planning system;
• reducing red tape and regulation;
• investing in transport and the housing stock.

The programmes to increase employment opportunities include:

• helping people move from welfare to work (including support for single mothers);
• easing the transition to work;
• making work pay;
• securing progression once in work.

The aim was to ensure a higher proportion of all people in work than ever before by 2010. Specific policies to achieve these goals include the New Deal programmes and the Working Families’ Tax Credit.

The Building A Fairer Society, Delivering High Quality Public Services and Protecting The Environment programmes are as much social as economic although their long-term effectiveness will bring economic advantages.

The Pre-Budget Report contains an immense amount of detail on each of the areas the Chancellor wants to tackle as part of his microeconomic reform, and there are very clear links made with the macro environment and the ability of the government to fund the various schemes.

Financial stability objective

The addition of a financial stability objective in 2008 was inevitable after the turbulence in the banking system, which was not confined to the UK. There were three aspects highlighted:

• support stability and restore confidence in the financial system;
• protect depositors’ money;
• safeguard the interests of taxpayers.

Unlike most of the priorities highlighted in the whole series of Pre-Budget Reports, the focus on financial stability was very obviously a defensive response to instability on international markets that could have had huge implications for the global economy.

Action had already been taken on the points above and the inclusion in the 2008 Pre-Budget Report explained and justified the steps that had been taken and put them in the context of broader government policy.

Present microeconomic policy - resilience and management of change

Although far less ambitious than previous initiatives, such as Labour's National Plan in the 1960s and the Industrial Strategy in the 1970s, the present microeconomic policy approach benefits from its carefully targeted objectives, its transparency and will be more resilient to a downturn in the macroeconomic environment.

It also recognises that the role of government is not to protect the status quo but to manage the change that is constant and inevitable in a global economy.

This was evident in the government's attitude to the collapse of Rover in April 2005 and in Tony Blair's criticisms of the EU and farm subsidies through the Common Agricultural Policy.