Hamish McRae: Instead of fighting old battles, the Tories should focus on how to modernise Britain

A new leader ain't much use without new policies. But what should we ask of the new Tory leader as and when he (it evidently won't be a she) is in post?

A new leader ain't much use without new policies. But what should we ask of the new Tory leader as and when he (it evidently won't be a she) is in post?

Nearly all of the debate about the appropriate policies to entice the voters away from New Labour has been in left and right terms: how far should the party lean to the right and away from the centre.

This is rerunning in large measure the battles of the past rather than thinking strategically about the role of government in the competitive globalised world economy of the future. The next generation will take a radically different path to that of the past one, and countries that have governments that adapt to this will prosper at the expense of those that don't.

The world economy will be different in four main ways: demography, globalisation, deflation and mobility. A word about each and some thoughts about the way in which politicians will have to respond.

First, developed countries will become the oldest societies (in terms of the ratio of older people to younger ones) that humankind has ever known. The response of Labour has, rightly, been to focus attention on the implications for pensions and, wrongly, to undermine the private pension system by increasing taxation on it.

But pensions are really quite a small aspect of the matter. Yes, more funds will have to be set aside by society to cope, and we will have to accept slightly slower growth in living standards now. But more important than fixing pensions is changing the way we live and work.

Were you approaching this from first principles, you would not have any retirement age as such. Instead, you would create various ways of helping people save for their own age (either through the state or individually) and encourage employers to find ways of boosting part-time working for elderly people. You would also run some sort of safety net for people who had been unable to provide for themselves.

The second change is competition from those two "new" kids on the block, China and India. They are not, of course, new at all, for they are much older civilisations than our own, but their entry on a major scale to the world economy is different from anything the developed world has experienced. This is much bigger than the growth of Japan or of the East Asian "tigers". For the next 30 years, the price of goods will be pushed down by the world's lowest-cost manufacturer, China. The price of many services - not all - will be pushed down by the lowest-cost service provider, India. We in the developed world have to figure out what we can do that other people on the other side of the world can't.

Government cannot fix this, but it can help create the conditions in which our society can try to adapt. First, it should do no harm. Much of the adaptation will be a result of improvement in our education system: we have to be cleverer, we have to push ourselves up-market. So it should give universities greater freedom rather than trying to run them as quasi-nationalised industries. It should probably do the same to the school system, looking at the best performers in Scandinavia, for example.

And beyond education, it should look in detail at aspects of government policy, such as onerous regulation, that push jobs offshore faster than naturally would be the case.

Next, it needs to consider the long-term implications of deflation, or at least price stability. Governments, along with most of the rest of us, still think of inflation as normal. Governments assume that tax revenues will rise in money terms. Well, in Japan, prices have fallen or been stable for more than a decade. The price of goods in Britain and the US has been broadly stable for four years. The only reason we have any inflation at all is the rise in services, including government services.

I don't think anyone fully understands what is happening, and in any case this shift to stability has been masked by the surge in house prices. But it probably has something to do with the point noted above, the expansion of China and India as global traders.

The consequences for government will be the same sort of downward pressure on their costs as, say, retailers and manufacturers have experienced. In the short term, it will not be so direct and obvious - we cannot outsource government services to India, or at least not in a radical way. But a thoughtful Tory party would be considering what happens to governments that have to manage on stable or even falling receipts. Doing more with less is the challenge every company already faces. Yet governments anywhere have hardly begun to think about this.

Finally, mobility. We know, of course, that companies have become almost completely mobile. If it costs too much to make something here, they get it made in China. On the other hand, if investment prospects in the UK are better than, say, Germany, we get the plant and the jobs.

But now it is also people who are increasingly mobile. We retire to France, while the young French move to London. We get Italian professors to come and teach in our universities, but lose our dons to Harvard. That changes the nature of the political relationship. Governments have not just to win elections, though of course they have to do that. They also have to appeal to potential skilled immigrants and retain talented nationals. A wise government will help a country become a magnet for brains.

New Labour half understands this, but only half. It does not really think strategically. It has not made any radical changes to taxation, for example. Nor has it exploited the fact that access for many of the brightest university students has been made more difficult in the US. A wise Tory government would say: "We want the world's brightest young people not just to study here, but also to work here."

Our present government is not stupid. It can see most of this and has brought in bits of policies to try to shift the way it does things. But it has not really grasped the implications for this change in the relationship because it is very difficult to do so when you are power.

The opportunity for the Tories is to manage the relationship between this country and the world's brightest and most energetic people in a more active way. Is it tax? Probably a bit, for radical tax simplification would give a huge competitive advantage to the UK. But it is not just that. It is running an efficient, decent democracy, not just better than our continental competitors - that is not hard - but also better than the rest of the English-speaking world.