Would Labour find the Treasury powerless?

Kenneth Clarke can cut interest rates, but Chancellors are far less powerful than they seem

The Chancellor decides that there should be a cut in base rates - we'll leave aside his reasons for the moment - and interest rates duly fall. Is that an example of the unusual power of the Treasury, unusual, that is, by comparison with other countries, where decisions about interest rates are determined by the central bank, rather than the Treasury? Or is it precisely the reverse: an example of the way in which the Treasury appears powerful to outsiders, but actually has very much less power than many people think?

This issue is of considerable current importance. There have long been people - mostly, not always, on the political left - who believe that virtually everything that is wrong with this country is the fault of the Treasury. Every time there is some clear error of economic policy, be it sterling's experience in the Exchange Rate Mechanism or the Lawson boom, the Treasury takes a share of the blame.

But in recent weeks the debate has been given a new twist by two rather different stories. One is a spat between Gordon Brown and John Prescott about the place of the Treasury under a future Labour government. Gordon Brown would like to keep the present departmental structure, but wants to find ways of increasing its effectiveness in encouraging a better performance by the economy. John Prescott, by contrast, does not believe that this is possible; he believes that the ethos of financial control will continue to drive the Treasury to the detriment of the real economy.

The other story was the leaking of an internal Treasury memo, just this week, in which the Treasury acknowledged that it was at least partly to blame for some of the political disasters of the Tory government. These include the Child Support Agency and the commercialisation of the blood donor service. The problem is that the Treasury mandarins take too narrow a view of the role of other departments and, by simply applying financial criteria, end up with policy mistakes. Suddenly, Treasury-phobes have not only acquired some new ammunition (now even the Treasury admits it is flawed), but also two mechanisms for firing it (either reform the Treasury a la Brown, or remove some of its economic power, a la Prescott).

We should not feel too sorry for the Treasury, for it has weathered far greater storms. Perhaps the most serious political challenge to its power - the creation of a separate Department of Economic Affairs, in 1964, run by the then deputy leader of the Labour Party, George Brown - ended in chaos with the collapse of George Brown's National Plan. The folk-memory of that experience almost certainly scarred the Labour party sufficiently for it to avoid a re-run should it gain power at the next election.

None the less, there is a powerful case to be made that while the Treasury is still the most powerful of the government ministries and will remain so, it is already rather less powerful than it seems, and is steadily becoming less and less important as the years go by. It retains the power to make significant mistakes - though it is by no means unique among government departments in that respect - but its positive powers are becoming more and more limited.

The most obvious example occurred yesterday. The Chancellor cut interest rates. Now it is possible that his Treasury advisers disagreed with him about the wisdom of this, but for the purposes of argument let's make the unrealistic assumption that the Treasury and incumbent Chancellor actually think the same thing. We will know what the Bank of England thought when the minutes are published in six weeks' time. So from the outside it looks as though the Treasury is exercising its power to change interest rates.

But look what actually happened in the financial markets. Bank base rates came down, but there was no immediate change in the rate of interest on consumer loans or on credit cards. Some building societies changed their rates, but others didn't. And, most crucially, long-term interest rates, as measured by price changes in the gilt market, actually rose. Because the markets distrusted the motives of the Chancellor - or at any rate were unconvinced by his argument in favour of the cut - the actual change in rates to borrowers and savers will be much less than the headline change in base rates.

The interest-rate decision by the Chancellor probably has some effect, but very much less than the headlines suggest. Had a similar decision been taken by, say, the US Federal Reserve or the German Bundesbank, it would have been much more significant. So in theory our Treasury is unusually powerful in having the ability to set interest rates; but in practice that power is very circumscribed.

Much the same point applies to other aspects of the Treasury's work. Taxation? Company taxation is set pretty much by international competition, for no developed country can step far out of line without encouraging firms to relocate themselves. Differences in personal tax rates have narrowed, as high-earners in particular have become increasingly mobile. Even differences in the duty on tobacco and alcohol have tended to close within Europe, as the Calais supermarkets show.

Spending? Big decisions about spending are circumscribed by financial markets: governments can decide to run a big gap between revenues and spending and borrow the difference, but those that do eventually find they are forced to reverse their policies. So there is very little real discretion about the level of public spending. There is some discretion about what should or should not be in the public sector. Should, for example, governments sell off nationalised industries? But that is not a Treasury decision; and as virtually every government in the world is busy privatising large chunks of its economy, the political decision is more one of timing than of direction. And, of course, the more of the economy that is in the private sector, the less the Treasury is involved in its investment decisions.

None of this is to say that the Treasury is unimportant, for incompetence in running public finance can do a lot of damage. Over-zealous attempts to micro-manage the budgets of other Whitehall departments do a different sort of damage, as that leaked memo admits. Everywhere, top-down authoritarian managerial styles do not achieve the objectives they intend, because they take away responsibility from people who know what they are actually doing. Here the Treasury is simply catching up with good management practice, and not before time.

The big issue is surely different. There is a grand historical process taking place that is reducing the power of governments as taxers and spenders and increasing their power as regulators. The Treasury controls taxing and spending. Other agencies regulate. Becoming a clever regulator is becoming as important as being an efficient taxer and an astute spender.

In Britain, the trappings of power are always substitutes for real power. The House of Lords, the Royal Family, the Foreign Office, the Lord Mayor of London, all appear powerful. But of course they matter less and less. I'm sure the Treasury is heading, albeit more slowly, in the same direction. A new Labour government would discover just that. They will pull the levers at the Treasury and expect things to happen, but they will find that at the other end no one pays that much attention any more.