Stephen King: Chancellor will be judged by quality not quantity of services

So, budget week and the usual leaks and speculation. Of course, Budgets these days are no longer what they used to be. Once upon a time, they were shrouded in secrecy. When I was at the Treasury in the mid-1980s, Budget secrecy was of paramount importance. On one occasion, I left a Budget paper on my desk overnight – full of the Chancellor's tax-cutting plans – and got my wrists severely slapped the next day. Nowadays, a Treasury official could reveal exactly the same level of information simply by leaving a copy of a pre-Budget Financial Times lying around.

Rather than speculating on the precise contents of Gordon Brown's budgetary plans, I'm going to focus instead on the medium-term picture. After all, Mr Brown is a man of prudence, a man who wants to go down in history as a truly great Chancellor, a man who wants to make his mark on the UK economy. The details of his annual Budgets may invite a huge amount of speculation but, for Mr Brown, it's the grand plans that matter. And their success will be revealed only gradually, piece by piece, over a number of years.

When New Labour came to power in 1997, Mr Brown had three primary objectives for fiscal policy. First, he wanted to put the public finances on a sound medium-term basis through the so-called "Golden Rule", which allowed him to borrow over the course of a cycle as a whole for investment purposes alone. Second, he wanted to encourage and promote the medium-term "trend" performance of the UK economy. Third, within economic cycles, he wanted to use fiscal policy to support monetary policy in helping to dampen variations in economic activity.

The juxtaposition of the first and third objectives is important. The first rule deals with Mr Brown's claims of prudence – he will not go back to the big structural budget deficits associated with Old Labour. Equally, though, he is not prepared to impose a fiscal strait-jacket on a cyclically depressed economy. In current circumstances, therefore, he can happily argue that he should be running a budget deficit not just for investment purposes but also to provide broader support to the overall economy. In the spirit of his fiscal rules, he is absolutely right: having run budget surpluses over the last few years, he can now run budget deficits so long as the cumulative deficit from now on roughly matches the cumulative surplus built up in earlier years.

Of course, these arguments don't let Mr Brown completely off the hook. His projected deficits will have to be based on some sensible economic numbers. At this point, there could be good reason to question Mr Brown's arithmetic. As I argued in this column a month ago ("The world changes while Gordon fiddles with his calculator") the Chancellor is likely to be too optimistic on growth and, at the same time, assume too much tax revenue for a given level of economic activity. Mr Brown will be sorely tempted to come up with a series of projections that will leave him with an annual deficit of around 2.5 per cent of GDP over the next two or three years. However, according to John Butler, my colleague at HSBC, a figure of 3.5 per cent of GDP is more likely over the medium term given the risk of further shortfalls in economic growth.

These numbers don't look too good. The issue for Mr Brown, however, is one of time. Whether or not the deficit is bigger than the Chancellor expects in the short-term, he will not have to do anything about it for a few more years – he can simply say that he has promised to balance his books through the course of a cycle as a whole. And, as we haven't yet reached the end of the cycle, he doesn't need to act now. Put another way, there may eventually be a need for higher taxes or cutbacks in public spending but, using Mr Brown's methodology, the necessary action will take place in the next Parliament, not this one.

What about the second objective, the idea of supporting – even raising – the "trend" rate of economic growth? Here, I think the Chancellor is on decidedly sticky ground. Take a look at the charts. The left-hand chart shows labour productivity growth in the private sector and, more specifically, the manufacturing sector. The right-hand chart shows the investment/GDP ratio together with the growth rate of profits. Neither chart is encouraging. Since Labour arrived in office in 1997, the growth rate of productivity has been persistently lower than the long-run trend. Meanwhile, the investment share in GDP has fallen back at an alarming rate. Of course, the UK is not the only country to have seen a collapse in investment spending: the US has been through exactly the same thing over the last couple of years. At least, however, the US has continued to enjoy strong productivity growth. As ever, therefore, productivity appears to be the UK economy's Achilles' heel. These observations present the Chancellor with a tough challenge. He can fiddle around as much as he wants with estimates of where we are within the cycle but what really matters over the long term is whether the economy is structurally strong enough to support Mr Brown's ambitions for public spending. To the extent that growth has been disappointing and inflation has been higher than expected, the economy is clearly not behaving in the ideal way to support claims of a faster "trend" rate of economic growth.

At this point, Mr Brown is in a spot of bother. To meet his public spending ambitions, he may increasingly have to rely on revenue-raising measures rather than economic growth itself. That threatens a move back to Old Labour "tax and spend". Moreover, to maintain public support for his spending plans, he needs to be able to show that they are working. At the macroeconomic level, the best way to demonstrate success is through productivity: after all, more education, a better health service and a better transport infrastructure should all contribute to higher output per man hour. So far, Mr Brown has chalked up only a very low score on this second, and perhaps crucial, objective.

Which brings me neatly on to my own difficulties. Last week, I rather stupidly fell over when skiing down a very easy Austrian piste. Something popped in my knee. Over the following few days, I was examined, injected, ultrasounded, X-rayed and scanned and discovered that I had snapped one of my cruciate ligaments. At all times, I was treated with efficiency and speed by a highly motivated and patient-centric medical team and I – almost – enjoyed the whole experience. When Mr Brown's spending plans start to focus on the quality of output rather than inputs and numbers of outputs, then we will really know that public spending is being reformed in ways that may eventually have some positive impact on the long-term performance of the economy.

Stephen King is managing director of economics at HSBC.

stephen.king@hsbcib.com